Another week of heightened inflation expectations led a simultaneous retrenchment of stock and bond indices.
Markets are now experiencing a situation vaguely resembling the infamous 2013 “Taper Tantrum”, a violent bond and stock market reaction to the Fed’s plan of tapering Quantitative Easing. In a world where risk is actively suppressed by central bank policy, assets become more correlated and inflation is the only realistic inhibitor to the kind of unfettered accommodation that has driven risk asset performance for a decade.
Will inflation end the “central bank era” for financial markets? First, we have to note that long term market expectations are not a reliable predictor of long term inflation, as they correlate more with inflation in the next two months than with consumer prices in the next five years. Second, central banks have signalled that they are willing to tolerate higher short term inflation, currently exacerbated by the effect of year-on-year calculations, a global supply chain crunch and demand boosted by the expected end of lockdowns and fiscal stimulus.
We continue to listen to what central banks are saying and presently subscribe to their views. The year-on-year effect will pass, global supply chains will eventually repair themselves and demand will probably flatten out after the initial post-lockdown boost and the withdrawal of fiscal stimulus.
In fact, governments are getting ready to end Covid-era fiscal easing for fear of an increased debt burden. Ahead of the UK Budget announcement on the 3rd of March, the government has signalled that it is as anxious to fund businesses that have suffered from the Covid-19 crisis, as it is to reign in fiscal spending and avoid deficits it may find difficult to tackle. Investors would do well to remember that this environment, where additionally unemployment could well remain elevated vis-à-vis pre-crisis levels, is hardly conducive towards long-term inflation. With risks in fact mostly on the deflationary side and the need to manage global debt levels, we expect the big central banks to remain active in steering risk assets for the foreseeable future.*The views expressed are the author’s and not ICAEW