Market updates from May
Inflation has been the main focus of markets recently. As the global economy emerges from lockdowns, we’ve seen commodity prices move sharply upwards and strain placed on some supply chains, pushing prices higher. There’s also evidence recruitment is proving more challenging than expected in certain industries. All this is putting upward pressure on prices more widely. This was brought to light through the US’s latest Consumer Price Index figure, pointing at a 0.8% rise over the last month and nudging up the annual rise to 4.2%.
This has heightened investor thinking that we are entering something of a regime change in the inflation backdrop, which would have repercussions throughout capital markets. Central Banks remain resolute that this inflation pop was inevitable as economies shift back into gear and have been reinforcing their message that this will turn out to be transitory. Indeed, given the Federal Reserve’s shift to ‘average inflation targeting’ this is all within their expectations. Investors are perhaps beginning to be a little bit more circumspect.
Following the sharp rise in yields earlier in the year, bond markets have been relatively calm and US 10yr Treasury Yields remain below their March highs. This masks some of the moves in inflation expectations, however. As Deutsche Banks’ Macro Strategy group note, 10-year inflation breakeven rates are at 8 year highs and the 5 year rate the highest since 2008. Within equities, the ‘recovery trade’ has taken a bit of a pause over recent weeks despite the gradual re-opening of US and UK economies and we’ve seen some moderate volatility as markets have largely moved sideways with Tech-growth taking the most pain.
Given this renewed uncertainty, it’s been a more difficult environment to navigate. On balance, we find it hard to fight against central banks and are currently more aligned to their view that the inflation will be transitory, and a more meaningful inflationary regime change is still some time away. However, our conviction in this view is not high and we are continuing to watch this closely and how market pricing moves. We do think volatility will remain elevated as we go through a period of adjustment though. Ultimately, a key defence against a more challenging environment is to continue to be well diversified across our portfolios.
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