'Jammed and distorted': investors are wrestling with inflation that may test the Fed's framework
By Christine Idzelis
'Rates are too low,' says a Boston-based portfolio manager.
Investors are facing choppier markets as they wrestle with signs of inflation in an unusual stretch of history.
In the past, the Federal Reserve seemed to regard inflation as "a big, slow moving, tsunami-like wave that they need to stop before it starts getting momentum," Anne Mathias, head of global rates and currency strategist at Vanguard Group, said in an interview. Now the Fed is willing to let it run hot by targeting an average 2% over an unknown period of time, making it tougher to predict a potential move toward tightening its policy, according to Mathias.
"It's really tricky," she said. "It makes it harder for the markets."
As the economy rebounds in the pandemic, markets appear to believe the Fed won't be as patient as it keeps reiterating (https://www.marketwatch.com/story/waller-says-fed-cant-be-head-faked-by-poor-hiring-and-high-inflation-in-april-11620925878?reflink=mw_share_twitter%20justified.) in the face of rising inflation, and that it will lift interest rates sooner than expected, according to Mathias.
Fed fund futures on Friday showed the market anticipates the Fed will hike rates in the first quarter of 2023, said Todd Colvin, a senior vice president at brokerage firm Ambrosino Brothers who trades rates on the floor of the CME Group in Chicago, in an interview. That's earlier than Cleveland Fed President Charles Evans indicated in late March (https://www.marketwatch.com/story/fed-might-not-raise-interest-rates-until-2024-evans-says-11616695610), when he said the U.S. central bank might not raise interest rates until 2024, MarketWatch reported at the time.
"After years of dormant inflation, a surge in prices could put the Fed's new average inflation-targeting framework to the test," David Kelly, chief global strategist at J.P. Morgan Asset Management, said in a May 12 note. The new framework, outlined by the Fed (https://www.marketwatch.com/story/fed-unanimously-adopts-new-strategy-widely-seen-as-leading-to-easier-policy-2020-08-27) at its Jackson Hole economic policy meeting held virtually last August, leaves "a pretty long lag" in terms of reacting to inflation, Kelly said in an interview. While the Fed expects any spikes in consumer prices will be transitory in the reopening (https://www.marketwatch.com/story/feds-williams-says-inflation-to-top-2-for-rest-of-the-year-but-decline-after-economy-is-recovered-11620066120), "how will you know until about a year after inflation shows up?"
Stock markets will see heightened volatility as investors continue to digest fresh data on inflation, according to Kelly and Peter Andersen, a portfolio manager and founder of Boston-based Andersen Capital Management. Equities tumbled (https://www.marketwatch.com/story/stock-futures-point-lower-ahead-of-inflation-data-11620816922?mod=market-snapshot) May 12, for example, after investors learned that the consumer price index soared in April, driving the inflation to its highest rate since 2008 (https://www.marketwatch.com/story/u-s-inflation-climbs-in-april-to-the-highest-level-in-13-years-cpi-shows-11620823628?mod=mw_latestnews).
"Signals of inflation right now are so jammed and distorted because we're in a turnaround period," said Andersen. "We're coming out of a history-making disruption," he said, so "we can't use the classic tools that we use in a sleepy, slowly growing economy."
Not being able to rely on traditional frameworks or measures may be driving some investors "crazy," said Andersen, who believes the stock-market selloff on the CPI data wasn't justified, partly because it's tied to the economic reopening (https://www.marketwatch.com/articles/dont-be-fooled-by-aprils-inflation-jump-its-being-driven-by-reopening-quirks-51620847392) in the wake of the coronavirus pandemic.
He said he is baffled by this year's drumbeat of concern that rising interest rates must spell trouble for growth stocks, with the chain of logic being inflation will lead to higher 10-year Treasury yields that will in turn hurt high growth companies. Sure their future earnings will be discounted in dividend discount modeling, he said, but that's just one input for analyzing stocks.
Read: There is a 'super sale' in Big Tech and other 'high-quality' stocks, says this fund manager (https://www.marketwatch.com/story/there-is-a-super-sale-in-big-tech-and-other-high-quality-stocks-says-this-fund-manager-2021-05-13)
The "specter of higher inflation" and interest rates is "overshadowing the tremendous" business success of these companies, said Andersen. He is bullish on growth stocks and says he doesn't fret over tiny basis-point moves in the 10-year Treasury yield , which remains below 2%.
"It's peanuts," he said. "Rates are too low."
Yield on the benchmark Treasury note was trading around 1.63% on Friday afternoon. Kelly agrees that the benchmark rate is low, recalling that it has fallen from double-digit levels decades ago. Vanguard's Mathias said the 10-year Treasury yield is near the low end of the range she expects to see in the next three to six months, with the top end being slightly more than 2%.
"There's still a lot of complacency in markets," Kelly said. "Everybody's talking about inflation, but nobody's doing anything about it in terms of pushing up long term rates."
That's despite inflationary pressure building beyond the CPI report, including the reading on the U.S. producer price index (https://www.marketwatch.com/story/u-s-wholesale-prices-rise-at-fastest-pace-since-2009-ppi-shows-as-inflation-pressures-keep-building-11620909721) being "very strong" and wage growth picking up, according to Kelly. McDonald's Corp. (MCD) plans to raise pay for employees (https://www.marketwatch.com/story/mcdonalds-raises-pay-an-average-of-10-for-u-s-restaurant-workers-11620912843) at company-owned restaurants in the U.S., the Wall Street Journal reported May 13, citing the fast-food chain as "one of the latest companies to bolster wages and benefits as they struggle to hire workers."
Read: Stock-market investors are jumpy because it's hard to tell 'good' inflation from 'bad (https://www.marketwatch.com/story/is-this-good-inflation-or-bad-inflation-stock-market-investors-are-rattled-because-they-cant-tell-11621022033?mod=william-watts)'
As for stocks, Citigroup strategists said in a May 13 research report that a strong rebound in global earnings per share is "usually enough to counter investor fears about rising rates" during the first year of a recovery. That means global EPS could "drive equities higher despite concerns about central bank tightening," according to the Citi Research note.
It's typically in the second year -- so in today's case 2022 -- that "EPS momentum fades and markets struggle," the strategist said in the report. "We would buy into any short-term dip in the markets and cyclical stocks in particular," they said. "It's too early to give up on the recovery trade."
U.S. stocks jumped on Friday (https://www.marketwatch.com/story/u-s-stock-futures-rise-ahead-of-retail-sales-data-11620992102?mod=market-snapshot), though major stock benchmarks remained down for the week after turbulence tied to inflation concerns. The S&P 500 index fell 1.4% last week, while the Dow Jones Industrial Average slid 1.1% and the Nasdaq Composite dropped 2.3%.
The U.S economic calendar (https://www.marketwatch.com/economy-politics/calendar?mod=economy-politics) for the coming week includes manufacturing data, housing starts, and minutes from the Federal Open Market Committee. JPMorgan's Kelly expects the Fed will probably start talking about tapering its asset purchases at its next annual Jackson Hole meeting this summer.
"Interest rates are at the wrong place," Kelly said. "Higher inflation is the thing that can push interest rates back to the right place," moves that will create more volatility in stocks, he said.
-Christine Idzelis; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires
May 15, 2021 08:52 ET (12:52 GMT)
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