Inflation likely to be transitory, but tapering narrative will stay for some time
The narrative of economic recovery is increasingly being challenged by the risk of central banks tapering asset purchases. Recent monthly US core CPI and core PCE readings were their highest since the early 1990s and well above the Federal Reserve’s target rate. The concern is that the Fed will reduce liquidity support sooner than expected.
The spike in inflation is likely to be transitory given the low base set during the lockdowns last year and as economies gradually normalise, but this is not to say that inflation cannot become more persistent later on. It’s important to track economic data points including non-farm payrolls, jobless claims, PMIs, inflation and yields, and all these feed into the other great tension at the moment in equity markets between cyclicals and growth stocks.
Broadly speaking, prints that confirm a hotter economy support cyclicals while undershoots support growth stocks. Central bank communications will also have to tread carefully to avoid spooking the markets. In addition, a global corporate tax floor, agreed in principle by G7 members, will disproportionately affect multinational growth companies.
Equity markets look ahead, and they are currently watching early 2022 when tapering is expected to start. If central bankers can get equity traders accustomed to the idea, there could be a relatively benign effect from a reduction in monetary support, but it’s a difficult balance. Stock pickers can protect themselves with companies that have the pricing power to withstand higher costs.
