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The Prospect of Inflation is Deflating Risk Assets


  • Investors are getting jittery over inflation, even though the U.S. Federal Reserve has pledged to hold rates down for longer
  • Lower-than-expected job growth numbers out of the U.S. last Friday provide more than enough grounds for the Fed to keep rates lower for longer, in line with broader employment grounds 

The jury is still out on inflation, but investors are already voting with their feet.

Ahead of Tuesday’s Chinese factory gate prices, an early indicator of price pressures for western importers, and Wednesday’s U.S. headline price data, investors are bracing for growing signs of inflation.

Expectations for Chinse factory gate prices are a rise of 6% while U.S. headline price data is expected to come in at 3.6%, with many investors speculating that the U.S. Federal Reserve will need to act, either through constricting monetary policy or easing off asset purchases.

Why investors are jittery is less clear though, with the Fed having pledged to remain relaxed about its 2% inflation target until the U.S. reaches full employment.

The Fed has also indicated that it has no plans to reduce its US$120 billion monthly bond purchases that have kept a lid on U.S. Treasury yields, which influence borrowing costs worldwide.

Yet somehow investors have decided to focus on the prospect of inflation, instead of the reality that poorer job data last Friday has provided precisely the justification for the Fed to maintain the status quo for longer.

If nothing else, several months of strong inflation data hitting bond prices and pushing yields higher, may even spur the Fed to ratchet up purchases.

Rising bond yields depress valuations of stocks, particularly long-term growth stocks such as tech firms, which do not pay generous dividends.

Some analysts suggest that tech stocks, which were the darlings of the pandemic, may find it hard to sustain their current levels of earnings growth as lockdowns ease and tax reform in the U.S. may see these companies exposed to higher levels of exposure.

But these views also assume that the pandemic is more or less over, even though it’s not.

While the U.S. is recording its lowest level of infections in 11 months, over in India, the coronavirus is sweeping across the country like a wildfire, with the potential for mutations to defeat existing vaccines high.

In other countries where the pandemic had been presumed to have been defeated, fresh outbreaks are erupting, straining healthcare infrastructure once again.

And last Friday, only 266,000 new jobs were created in the U.S., well below forecasts and a sign that the Fed’s key metrics for withdrawing support are nowhere close to being met.

That in and of itself should provide some food for thought for skittish investors dumping tech stocks and pricing in tighter conditions.

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© Copyright of Novum Global Consultancy Pte Ltd {2020, 2021}. All rights reserved.

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