May 17, 2021

Inflation Fears Spark Mild Sell-off

Global equity markets swooned, with US and Chinese equities bearing the brunt as several inflation readings surprised to the upside. Disappointing credit data from China piled on. The hot inflation numbers dealt a blow to fixed income investors, too, as bond yields rose. Longer-term yields rose more than short, steepening the yield curve. The financials and consumer staples sectors managed gains. Financials benefitting from the steeper yield curve and consumer staples due to their wares being more price inelastic than discretionary items. Growth sectors and new-economy stocks were hardest hit. The S&P 500 Growth Index fell 2.1% vs. a 0.6% decline for the Value Index.  

Inflation running hot is no surprise now that we are measuring against last year’s deep pandemic lockdown-induced price declines. As the list of colossal ‘misses’ on the part of the collective pundit community continues to grow longer and longer, investors should be getting used to forecasted expectations missing by large margins. Add this week’s US inflation miss (CPI of 4.2% y/y versus 3.6% expected and core inflation 3.0% versus 2.3% expected) to the botched calls on US April employment (266K vs. 1 million estimated) or the corporate earnings estimates that have been blown away by actual figures. Both US and European Q1 corporate earnings beat already elevated consensus analyst estimates by over 20%. Canadian earnings are beating estimates by 8%. Before we declare Canadian analysts more prescient than others, remember that earnings reporting in Canada lag the rest of the world (2/3rds of Canadian companies have reported thus far, vs ~90% in the US and Europe). Suffice it to say; our crew had a heads-up. The fact of the matter is the unprecedented crisis and response shook the world up so much that we will need to brace for this kind of data turbulence for several more months at the earliest. 

Digging through the numbers on US inflation, there is evidence to suggest that the spike is leaning toward the ‘transitory’ argument. The outsized jumps were concentrated in the areas hardest hit by the pandemic that began to reopen in earnest in recent months – for example, airfares are up 10% m/m, hotel room rates +9% m/m. These items will likely see more increases as hotels are still down 6% and airfares 18% from pre-pandemic levels. Other measures of inflation are up, but by more modest amounts, amounts that the US Federal Reserve (Fed) will be able to live with, and indeed desires. The Cleveland Fed’s median inflation measure rose 0.1% to 2.1% y/y, and the Atlanta Fed’s core sticky inflation figure jumped 0.6%, but only to 2.27% y/y. For now, Fed officials continue to push the “inflation is transitory” argument. Ultimately it will be inflation expectations that drive the Fed’s decisions. Unfortunately, inflation expectations are on the rise. Expectations for 5-year inflation 5-years from now (Fed’s 5yr forward model) have jumped 0.5% YTD to just shy of 2.5%. The University of Michigan Consumer Sentiment Survey’s 5-year inflation expectations measure jumped to a 10-year high of 3.1%. If these inflation pressures and heightened expectations persist into mid-summer, the Fed will face a tough time sticking to their transitory narrative. That leaves capital markets with uncertainty we know they don’t like.

The week ahead

• Canadian and Chinese retail sales data
• Canadian and US housing data
• Canadian, Eurozone, UK and Chinese inflation data
• Eurozone and UK consumer confidence
• Eurozone and Japanese GDP data
• Eurozone and Chinese trade data
• Chinese industrial production and fixed asset investment data
• Global Purchasing Manager Indices
• 19 S&P 500 and 4 S&P/TSX companies report earnings