Market factor

Inflation could be the most important market driver in 2021

The start of the new year is usually littered with many forecasts from economists and strategists as to where the markets might go and what the economic outlook might look like. To a large extent, all the predictions about shocks and surprises until 2021 have been rendered unnecessary by the drama and tragedy of 2020. All that follows will be calm in comparison, and calm is what most people think of. ‘between us want.

Is inflation dead?

One economic trend that many economists like to predict is rising inflation. They could be forgiven for doing so given the amount of liquidity in the global system. However, those who promise higher inflation, in addition to the many central banks mandated to support inflation – notably the European Central Bank – have failed to see it recover.

There are several structural reasons for this – demographics in the United States and China are cooling economies, some banking systems – again notably in Europe – have not transferred liquidity to the real economy as they once did. .

It also appears that much of the central bank stimulus has been used to produce asset price inflation rather than retail or consumer price inflation. The behavior of stock markets over the past two years is a good example of this and suggests that the economic cycles of yesteryear have now given way to the liquidity cycles of our time.

Liquidity cycles

A better illustration of the intersection between consumer price inflation and asset price inflation is the behavior of lumber prices in the aftermath of the first wave of the coronavirus. Lumber prices have recovered strongly, apparently signaling a rebound in real estate activity and creating higher costs. Further investigation suggested lumber futures move more in line with Apple’s prices

AAPL
and Tesla

TSLA
, and with a strong recovery in lumber futures volumes, indicated that speculative trade was the source of the recovery in lumber.

It helps to connect markets and economies. A real rise in inflation could have a strong impact on the market, either through a downward revaluation of bond prices (keep an eye on the MOVE bond volatility indicator), or through a reluctant return to the generosity of purchases. central bank assets and a revaluation of the central bank. Politics.

Upset on the way

The possibility of an inflation “shake-up” is worth persisting because of at least two factors.

The first is that the ground is now laid for better policy coordination – first between regions like the EU and the United States, and then between monetary and fiscal policies. The appointment of Janet Yellen as Treasury Secretary is key here with US and EU budget deficits and expanding ECB / Fed balance sheets. The idea is that stimulating fiscal policy (provided the stimulus checks don’t all go to Robinhood!) And accommodating monetary policy will boost the velocity of money in the real economy.

The other is that the fuel for higher inflation – healthy corporate cash flows and household balance sheets (debt service has collapsed), improved lending standards in the United States. is in place, with activity normalizing in the United States, slowly recovering in Europe and accelerating in China.

The markets usually react strongly to something they haven’t experienced recently. Over the past decade, markets rather than central banks have rightly called the “death of inflation”.

Expect the unexpected

However, instruments like inflation swaps have started to recover, and the market risk here is that central bankers see a long overdue inflation pickup as a “good thing”, not adjusting for it. their policy and thus stimulate a trade in commodities, cyclical stocks but which sees an acceleration of the exit of bonds. 2021 could be the first time in more than a decade that inflation forecasters could get what they want.


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