Stocktake: Are investors underestimating inflation threat?

Inflationary pressures may prove more ‘sticky’ than investors believe, warns market strategist

US inflation hit a 13-year high of 5 per cent last week, but markets’ nonchalant reaction suggests investors share the Federal Reserve’s view that the uptick will be temporary.

Last month’s Bank of America fund manager survey found high inflation was viewed as the biggest tail risk facing markets. Those fears have subsided lately, as evidenced by stock market calm and 10-year bond yields falling back below 1.5 per cent.

Inflationary pressures may prove more "sticky" than investors believe, cautions market strategist Jeroen Blokland. He notes the St Louis Fed Price Pressures Measure indicates an 84 per cent chance inflation will exceed 2.5 per cent in the coming year.

Between 2004 and 2006, says Blokland, when the price pressures measures stayed elevated for a prolonged period, US inflation averaged well above 3 per cent.


Similarly, a National Federation of Independent Business survey shows small business owners are more concerned about inflation than at any time since 1981.

Nevertheless, global markets are priced for a "prolonged period of inflationary somnolence", noted outgoing Bank of England chief economist Andy Haldane last week. Haldane thinks the inflation threat is underestimated, as does Allianz's Mohamed El-Erian. The assumption inflation will be transitory is "unfortunate", says El-Erian, as "both the scale and scope of the micro and macro data necessitate a more open mindset".

Inflationary pressures may well subside, but that’s not going to be clear for some time. Until then, says Blokland, “some stickiness of inflation should not be ruled out”.