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As the economy picks up pace through 2021, investors may have to deal with unexpected inflationary pressures, if only for a short time.
Bond market traders and Wall Street experts have been showing a rise in inflation from current sleep levels.
In fact, many are seeing inflation move towards and perhaps just above the Federal Reserve’s 2% target level that has been difficult for much of the last decade. The main driver of economic recovery is spurred by more Americans getting the vaccine, which will bring up price pressures in industries that have been held back at the time of coronavirus pandemic.
The trick, however, is to keep it there.
The Fed estimates some inflation is good for the economy, as it marks growth and allows the central bank room to have it the next time a crisis comes and seeks help from monetary policy. However, a number of factors have protested to keep inflation low, and it is likely to help with increases in the coming months.
“We expect interest rates to remain lower for the longer term and inflation,” said Sunitha Thomas, national portfolio adviser at the Northern Trust Wealth Management. “We’re expecting some inflationary volatility prints to come up, and the market is going to respond to that and try to find out what that means. I think that’s more of a cycle than a permanent one. “
At a Fed meeting earlier this month, Chairman Jerome Powell acknowledged that the economy could see some prices, possibly from rising energy.
However, policymakers would need to see a steady rate before taking any action, a position now codified under Fed’s average-inflation flexible approach that it agreed a few months ago.
“Inflation will not be easy to move up.… It will take some time,” Powell said at a news conference after the meeting. “What we are saying is that we will be keeping a very appropriate policy so that the expansion is far down the lines. And we’re not going to raise rates positively until we see inflation reach 2% and be on track to be above 2%. That is a strong commitment, and we believe that it is the right place to be. “
The question of rising inflation and the Fed’s expected policy response is crucial as the market enters the next phase of a strong recovery that started off the low levels caused by pandemic.
Investors are increasingly questioning whether the market is heading into a bubble rate similar to the fall of 2000 dot-com, which was exacerbated by rising interest rates that were trying to keep up with growth.
“As we study the market reporting landscape going into 2021, the return of inflation, perhaps with retaliation, is a very common topic,” said Nick Colas, co. founder of DataTrek Research, in a note this week.
Colas pointed out that 5- and 10-year balance rates, or the difference between government bond yields and Securities under inflation protection, are both just a shadow below 2%. That represents two-year highs and is a measure of where the market sees the consumer price index.
An environment like this, Colas said, is not generally good for inflation-sensitive securities such as longer-term bonds “unless one believes the market’s commitment to 2021 global economic recovery has gone wrong. “
Ways for a sharp rebound
Goldman Sachs, for one, is at the top of the pack when it comes to hopes for the economy in the year ahead.
The company’s economic team sees full-year GDP growth of 5.9%, about 2 percentage points ahead of consensus estimates. Coupled with this growth forecast comes the expectation that core inflation as measured by the Fed’s preferred criterion, the deflator consumption personalization, will “soon kick above 2 % next spring as we weaken the weakest pandemic effects, “Goldman economists Alec Phillips and David Mericle said in a note.
“Several sectors should be kicked back from the direct and indirect effects of pandemic isolation, including flights, hotels, clothing, and financial services,” they said. “But the pandemic has had temporary-onset effects in sectors such as used cars and medical services, and the full impact of a weaker economy may not have come on shelter and other slab-sensitive basic service sectors.”
Goldman’s team said only a “very tight labor market” could push a stable inflation that would then force the Fed to raise rates, which is unlikely to happen any time soon.
Similarly, Citigroup economists expect inflation to push above 2% by April and stay there for several months, but then “settle back toward the 2% target by the end of the year.” The company sees rapid jumps in travel and clothing prices counteracted by reducing the costs of automation and medical services.
These expectations for a controlled inflation environment are helping to fuel a largely vibrant Wall Street view for another year of strong results.
“All of this has led to positive expectations for the reopening of the economy and greater confidence in employment prospects next year. We expect the Fed to remain very responsive and interest rates to remain lower for longer, “said Thomas, North. Securities adviser. “We look forward to 2021.”