US Federal Reserve walking fine line with approach to rising inflation

Name: Japanese town builds giant squid statue with coronavirus relief money
Uploaded: 2021-05-13T14:00:13.000Z
Duration: 48 s
Description: Japanese town builds giant squid statue with coronavirus relief money

While US policymakers might be willing to accept a period of higher inflation that lasts longer than a few quarters, markets are not as patient

The Fed is probably right that the spike in inflation will be short-lived, but its handling of the surge in prices is exacerbating concerns

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A worker restocks chicken in the meat product section at a grocery store in Dallas, US, on April 29. Rising prices for a variety of commodities are contributing to a jump in prices, with Americans paying more for meat, petrol, items they keep in their homes and even the homes themselves. Photo: AP

Nicholas Spiro

Published: 10:00pm, 13 May 2021Updated: 3:01am, 14 May 2021

The single most important matter in financial markets this year, and the one that will bedevil investors for some time, is the recent surge in inflation, particularly in the United States. The question is whether this is a temporary blip or the beginning of the end of a decades-long period of subdued consumer prices.

It is no exaggeration to say that low, well-behaved inflation is the foundation upon which rests everything in markets – prices, sentiment and asset allocation. For nearly 40 years, investors have not had to worry about the threat posed by inflation as central banks and governments around the world pursued policies that kept prices in check.

However, the Covid-19 pandemic has changed the policy landscape significantly. Unprecedented levels of monetary and fiscal stimulus have been unleashed to counter the economic devastation wrought by the pathogen.

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Japanese town builds giant squid statue with coronavirus relief money

Moreover, the US Federal Reserve adopted a new strategy last year that is more tolerant of temporary rises in inflation above the central bank’s 2 per cent target.

The combination of large stimulus packages, the mass roll-out of vaccines and the start of one of the biggest booms in history has pushed up inflation, putting pressure on long-term government bond yields. The benchmark 10-year US Treasury yield has risen nearly a full percentage point since early October last year to about 1.7 per cent.

Where there is smoke, there is often fire. An inflation scare that began earlier this year intensified this week. Technology shares, whose lofty valuations hinge on an upbeat outlook for earnings far into the future, are under strain amid fears that the Fed will be forced to raise interest rates sooner than markets anticipate.

Price pressures are increasingly rapidly. The publication of data on Wednesday showed the headline rate of US inflation last month hit 4.2 per cent year on year, its highest level since 2008. The increase was fuelled by a fierce rally in commodity markets, with the Bloomberg Commodity Spot Index, which tracks 23 raw materials, rising to its highest level in nearly a decade.

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