Releasing the inflation genie out of the bottle | May 2021



In this episode we’ll be looking at what’s happening in markets with the vaccine rollout underway and whether accommodative monetary and fiscal policy might come with an inflationary sting in the tail.

Releasing the inflation genie comes with market risks
It’s been a buoyant start to the year for financial markets, as accommodative fiscal and monetary policy and easing lockdowns have supported global recovery. However, there may be a sting in the tail if inflationary pressures rise.

The IMF recently forecast global real GDP to grow by 6.0% in 2021, which would be the fastest rate since records began in 19801. This potential rapid economic growth is leading to overheating concerns. For example, in the US, annual Consumer Price Inflation accelerated to 2.6% in March, the fastest pace in nine years, from a low point of just 0.1% last May2.

Higher inflation is exactly what the Fed wanted when it introduced its new Average Inflation Targeting in September 2020. This is designed to allow inflation to run higher in the short-term until recovery is well-established. However, given the unprecedented global stimulus combined with pandemic-led supply disruption, inflation risk is likely skewed to the upside.

The Fed is betting that there is sufficient slack in the economy to take away pricing power from companies so that any inflation will prove transitory. However, some pricing surveys show that this may not be the case. In March, the National Association of Independent Businesses, a body that represents small firms, showed that surveyed companies expected selling prices to reach their highest level in 13 years3. Businesses are taking the opportunity to raise prices amid low inventories, weak competition and pent-up demand.

The risk is that the longer the Fed continues to run loose monetary policy, the more difficult it may be to control inflation and longer-term interest rates. For the time being, we believe favourable policy and strong economic recovery are likely to drive company earnings and thus equities up further over the coming months. However, inflation risks have risen and need to be monitored.



1,2,3 Refinitiv Datastream



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This episode was recorded on  29/04/2021

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The Pulse from Smith & Williamson

Investment Show: Releasing the inflation genie out of the bottle

Episode 21

Broadcast on Smith & Williamson at 09:00, 7th of May 2021

Available online from 10:00 on the same day .

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