Markets Weekly

21 August 2020

5 minute read

Week ahead

With financial markets looking for continuing signs of economic recovery in the US, August’s consumer confidence and the University of Michigan consumer sentiment surveys are expected to point to weak domestic spending amid COVID-19 and the US slowdown.

The above is likely to be reflected by the second estimate for the US second-quarter gross domestic product, which is also out next week. The data will confirm the impact of containment measures on output. July’s core personal consumption expenditure index, the US Federal Reserve’s preferred measure of inflation, will probably stay subdued.

The weekly US initial jobless claims data on Thursday remain a focal point in determining the health of the economy, especially as investors look for signs of a V-shaped recovery. However, with some states being forced to close as a result of surging COVID-19 cases, high-speed data showing consumption slowing and the running out of government support measures, claims may remain at elevated levels.

In the eurozone, markets will eye a series of surveys with economic conditions improving in the region since the easing of quarantine measures and signs of more cohesion in the bloc after the fiscal package being agreed collectively. However, risks of a flare up in COVID-19 cases and persisting Brexit negotiations remain in the background.

In the UK, Chancellor Rishi Sunak’s summer statement included a temporary increase in the stamp duty tax threshold for property purchases. Given that house price growth in the UK has struggled leading up to this announcement, August’s Nationwide house price data should help gauge the policy’s effect.

Chart of the week

Is a higher inflation era near?

It is no surprise that inflation is likely to remain noticeably below 2% this year, the target for the US Federal Reserve (Fed) and the European Central Bank, and close to deflationary levels. But might inflation start to surge after the pandemic; especially with global monetary and fiscal stimulus at unprecedented levels?

Pandemic impact

At the beginning of the COVID-19 crisis in March, markets pricing of forward-inflation rates fell to very subdued levels. We previously argued that the move may have been overdramatic given the potential for a post-crisis world, with confidence, employment and consumption recovering, leading to upward demand-pull inflationary pressures.

Since then, and in particular in mid-May, expectations have rebounded to levels seen in the second half of 2019. The rebound may have more room to run.

Supply chain risks

Supply chains have been changed due to the crisis in two ways. First, far more companies are struggling to survive, lowering competition. Second, and a theme discussed in July’s See beyond: thematic investing, supply chains have seen the vulnerabilities of fully globalised integration.

As countries went into lockdown and closed their borders, it was those firms that relied heavily on trading partners for inputs and demand that struggled. It is telling that China, the world’s second largest economy, has decided to focus inwards in its next five-year plan, from 2021 onwards. These factors appear to point to price pressures.

Policy outlook

There is a lag between enacting fiscal policy and any resulting inflation. It takes time for measures to alter consumer spending and for this spending to circulate in the economy. Given the substantial amount of pandemic-related fiscal support so far and with the US contemplating a further injection of spending, higher inflation seems probable.

Furthermore, upward inflationary pressures are unlikely to be met quickly with hawkish action by central banks. The Fed’s policy review could lead to a higher inflation target, suggesting increased stimulus through more quantitative easing, or even negative interest rates, to meet the new target. Faced with the risk of inflation overshooting its target in the short to medium term, or interrupting economic recovery after record contractions, central banks are likely to prefer the former to the latter.

There is also the impact of base effects on 2021 inflation rates, such as from the plunge in the oil price seen in April and May this year. While the price has since rebounded, it may create large base effects next year. Given oil’s high inflation weighting in the basket, this could have a pronounced effect.

Chart of the week

Countering inflation risk

A move away from global integration and policy support measures in particular could boost inflation and lead to a higher inflation profile than seen in the past decade. With potential for more upward moves in inflation markets (see chart), investors may want to shield their portfolios from such risk through active management and a preference for quality companies and assets that tend to outperform in inflationary environments.


Delivering real bond returns

As inflation expectations climb, how might investors counter inflation risks?

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