US inflation comes in at more than 4 per cent compared to 12 months ago. Usually at that level, alarm bells in the investment world ring. This is because the Federal Reserve aims to target an inflation rate of around 2 per cent. Excessive inflation, in the past, often provoked interest rate hikes. And higher interest rates are bad news for equity and bond investors.
For now, however, the Federal Reserve is making little move. From the minutes of the last meeting, it appears that there is not even agreement yet to talk about phasing out all kinds of support measures. Indeed, the rise in inflation is mainly caused by a variety of temporary factors. Like an odd basis of comparison with a year ago, when the economy took the hardest hit from Covid-19 lockdowns. And a growing shortage of computer chips.
Temporary. Or not?
But these temporary phenomena could just be the harbinger of a more structural rise in inflation. If consumers and companies expect inflation to rise further, they anticipate this by charging more expensive prices and demanding higher wages now. This can create a wage-price spiral. Higher wage costs are then passed on in rising selling prices, which in turn lead to rising wages.
Whether it comes to that depends largely on what happens in the labour market. There are 8 million fewer Americans working now than in early 2020. However, that number could fall quickly once the increased unemployment benefits disappear in September and children return to school or daycare.
Still a little nervous
The financial world is seemingly not much worried about rising inflation. Interest rates in US bond markets are an important indicator of this. If investors fear that inflation really becomes an issue, they will demand a higher return on their money. There is no sign of that for now. The interest rate on 10-year loans of 1.66% is almost at exactly the same level as two months ago.
But equity investors are getting a bit nervous. For instance, the volatility index VIX is steadily rising. And CNN's fear/greed index, which measures how much risk investors are willing to take, has turned from greed to fear within a month. Moreover, the dollar has fallen 4% against the euro since the beginning of April. As long as inflation fears continue to simmer, the pressure on the US currency may just continue.
Joost Derks is currency specialist at iBanFirst. He has over 20 years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.
