Concerns about higher than expected inflation have weighed on investors over the past few months. In our March Markets in Motion, we discussed our view that structurally higher inflation is not a near term risk. This month, we’d like to elaborate further on that view and add nuance because we believe that the data will be a bit noisy over the coming months.
First, US consumer price inflation is trending up. Headline CPI rose 2.6% year-over-year in March, from 1.7%. It’s the first time it has exceeded the US central bank’s 2% inflation target since Covid struck. But base effects are a big part of the story. CPI plunged during last spring’s lockdowns, resulting in a significant base effect for March, which will only get stronger in April and May. So, the next few months’ data should continue to accelerate.
This is not surprising … expansionary factors like fast money supply growth (stimulus) and stronger demand (re-opening) are driving up prices. But with investor inflation expectations at/near all-time highs, we believe these current inflationary dynamics are already priced into markets. For example, 10-year treasury yields closed 5 bps lower on the day of the “blowout” CPI report. And reflation assets have been outperforming since September.
Moreover, a transitory pickup in inflation is a policy goal of the Federal Reserve. We believe the real risk to markets would be a more hawkish central bank. But we do not expect data over the next few months will make them flinch and future moves will continue to be dictated by labor market dynamics (which are a long way from normalization).
Finally, after a transitory pickup in inflation, we believe structural deflationary trends will reassert themselves. Technology continues to produce more (and better) goods & services at a lower cost while suppressing workers’ wages at the same time. Globalization and free trade (global and domestic) allows bigger labor pools to be utilized, leading to the production of more goods at a lower cost. And the pandemic accelerated structural low end job losses and already plunging global birth rates.
While structural deflation will continue to ease cost pressures, we believe that the biggest deterrent to near-term inflation will be inequality. Inflation bulls point to the >$2T extra cash in household accounts from post-Covid stimulus. But we believe this data is skewed, because ~70% of this cash has gone to the top 20%, which is always the group least likely to spend. Therefore, much of the extra cash will be saved and not unleashed into the economy. That’s why a savings glut on the balance sheets of already-wealthy households is unlikely to boost inflation in a sustained way.
Thus, we see a “goldilocks” environment for risk assets – where growth is strong, inflation is contained and monetary policy is accommodative. We continue to overweight stocks and credit over government bonds.
With this month moves, we sold our tactical position in treasuries and consolidated our equity book, adding to our international exposure.
Finally, know that all our Strategies will adapt to fundamental or rules-based, not emotional influences. We seek opportunities for solid risk adjusted returns and to preserve capital in asset market downturns.
Originally published by Donoghue Forlines, 4/28/21
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