It seems investors are now more concerned about the potential of a spike in inflation than they are about the Covid-19 threat. This can be seen clearly on bond markets, where bond yields for investment-grade issuances have been trending upwards since the beginning of the year.
The US 10-year yield for example, spiked to a high of 1.57% from less than 1% at the beginning of the year with much of the pressure coming through in the days leading to and after the US Federal Reserve chair Jerome Powell’s testimony to the US Congress. Jerome Powell played down the inflation flare-up fears and reiterated the Fed’s commitment to accommodative monetary policy stance.
Investors are front running the Federal Reserve, as they are concerned about the currently unutilized consumer pent-up demand, which also stands to benefit from the $1.9tn fiscal stimulus proposal. This combined with a swifter-than-expected recovery in economic growth and bottlenecks in the supply chain could cause inflation. However, the question is whether inflation will overshoot the 2.4% average targeted by the Fed because that is the level that will force the hand of the Fed. The Fed does acknowledge that US inflation will certainly go up but does not think it will go out of hand. We will not go into that discussion here. The graphs below show how assets have historically performed under different inflation regimes. If history was to repeat itself, then one would expect returns from all asset classes to be subdued. However, risk assets and gold would fare better than safe havens. But obviously, the circumstances we are in now are very peculiar, so the outcome this time is highly unpredictable.
Source: J.P. Morgan Asset Management
*High and low inflation distinction is relative to the median inflation rate (2.5% y/y) for the period 1988 to 2020. Rising or falling inflation distinction is relative to the previous year inflation rate. Returns are based on calendar year performance and are total returns unless otherwise stated.