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As the economy progresses to 2021, investors may struggle with unexpected inflationary pressures, even if only for a while.
Bond market traders and Wall Street experts point to rising inflation from current dormant levels.
In fact, many see inflation moving and perhaps slightly higher than the Federal Reserve’s target rate of 2% which has been elusive over the past decade. The primary driver is an economic reopening fueled by more Americans being vaccinated, which will cause upward price pressures in industries held back during the coronavirus pandemic.
The trick, however, keeps it there.
The Fed sees some inflation good for the economy as it indicates growth and gives the central bank room to act the next time a crisis arises and needs monetary policy assistance. However, a number of factors have conspired to keep inflation low, and this is likely to help prevent a rise in the coming months.
“We do expect interest rates to stay lower for longer and we expect inflation to remain limited,” said Sunitha Thomas, national portfolio adviser at Northern Trust Wealth Management. “We do think that there are going to be some volatile imprints on inflation, and the market is going to react to that and try to decipher what that means. We think it’s more cyclical than permanent.”
At the Fed’s meeting earlier this month, President Jerome Powell acknowledged that the economy could see price pressure, perhaps due to rising energy.
However, policymakers need to see a sustained level before acting, an attitude now codified under the Fed’s flexible approach to inflation targeting that it approved a few months ago.
“It’s not going to be easy to raise inflation. … It’s going to take a while,” Powell told his news conference. “What we are saying is that we will keep the policy very accommodating until the expansion is on track. And we are not going to raise rates for the time being until we see that inflation actually reaches 2% and is on course to exceed 2. is a very strong commitment and we think it’s the right place to be. ‘
Demand for rising inflation and the Fed’s expected policy response are critical as the market enters the next phase of a strong recovery that started lows in late March.
Investors are increasingly wondering if the market is entering a bubble phase like the dot-com collapse of 2000, exacerbated by rising interest rates trying to keep pace with growth.
“As we explore the landscape of market commentary in 2021, ‘the return of inflation, perhaps with vengeance’ is a very, very common theme,” DataTrek Research co-founder Nick Colas said in a note this week.
Colas pointed out that the five- and ten-year break-even rates, or the difference between government bond yields and the treasury inflation-protected securities, are both just a shadow below 2%. It represents two-year highs and is a measure of the market to which the consumer price index is heading.
Colas pointed out that such an environment in general is not good for inflation-sensitive effects such as long-term bonds, unless one believes that the market’s enthusiasm for a global economic recovery in 2021 is deeply misplaced .
Hoping for a sharp setback
Goldman Sachs, for one, is leading the group when it comes to hopes for the economy in the coming year.
The company’s economic team sees full-year GDP growth of 5.9%, about 2 percentage points ahead of consensus estimates. Along with the growth projection comes the expectation that core inflation, measured by the Fed’s preferred measure, the deflator for personal consumption expenditure, will ‘bounce back above 2% next spring while we have the weakest pandemic base effects’,’ say Goldman economists Alec Phillips and David Mericle said in a note.
“Several categories must fall back from the direct and indirect disinflationary effects of the pandemic, including air fares, hotels, clothing and financial services,” they added. “But the pandemic also had temporary inflationary effects in categories such as used cars and medical services, and the full impact of a weaker economy on shelter and other sluggish core service categories has probably not yet materialized.”
The Goldman team said that only a very tight labor market would cause sustainable inflationary pressures that would cause the Fed to rise, and that is likely not soon.
Similarly, Citigroup economists expect inflation to rise to 2% by April and remain there for a few months, but then return to the 2% target ‘by the end of the year’. ‘The firm sees rapid boost in travel and clothing prices offset by the cost of used cars and medical services.
These expectations for a controlled inflation environment help boost Wall Street’s prospects for another year of strong returns.
“All of this has led us to have positive expectations about reopening the economy and having more confidence in earnings expectations next year. We expect the Fed to remain very accommodating and interest rates to stay lower for longer,” Thomas said. , North North, said. Trust Advisor. “We look forward to 2021.”