Stripped of all frills, we can outline a few things about the financial markets as follows. Stock and bond prices are mainly rising on the expectation that the Fed will keep monetary policy very loose, if not loosen it. The Fed is going to do that because inflation is too low. But will it stay that way?
A change in the monetary rate is only expected if inflation rises by at least 2% per year for a long period of time. Recently, US inflation has risen to 2,6% annually. Yet the Fed is not concerned about this. The increase is mainly due to a statistical effect.
Today's prices are compared with prices a year ago. Because the corona crisis broke out in the spring of last year, prices came under downward pressure. Any comparison between now and then shows a significant increase. Like that 2,6%. The obvious conclusion is that the stock markets do not have to fear that the engine that has been pushing prices up for quite some time will run out of fuel.
Mathematical truth
The Fed is right that the aforementioned statistical effect is fading away. That's not a matter of agreeing or disagreeing with the bank, it's a mathematical truth. There is a good chance that this also applies to another effect, namely the increased oil price. This has risen from approximately $10 per barrel a year ago to between $60 and $70 this period. It is quite surprising that this will have a considerable upward effect on annual inflation.
If the same strong effect is to come from this direction in the coming quarters, the oil price must rise to $120 and more. Nobody expects that. From this perspective, the fact that inflation has risen in recent months and will continue to rise in the coming months is indeed no cause for concern. Add to the above that the economic recovery after the corona recession has yet to get off the ground and that this will probably happen from the summer onwards, that the governments, just like the central banks, continue to support the economy unabated and that due to the low interest rates, investors have no alternative to shares, and it is not too difficult to expect sunny months on the stock markets.
Danger lurks in
There is a danger in the above: that markets and policymakers are too convinced that inflation will not become a problem. Not in 2021, but in 2022, for example. We are used to looking at figures such as inflation on an annual basis. Normally there is nothing wrong with that, but nowadays it clouds the view of reality. For the time being, we must be careful about drawing firm conclusions from comparisons with a year ago. A year ago, many things were abnormal and showed behavior that occurs once a century.
Blessings in an accident: there is a way to improve vision for ourselves. This is by looking at the change in prices on a monthly basis (for example inflation) or quarterly (economic growth). So do not compare the prices from March 2021 with those in March 2020, but with those in February 2021.
Slight contraction in China
And with regard to economic growth: not so much looking at the growth in a quarter of this year compared to the same quarter in 2021, but compared to a quarter earlier. The recent growth figure from China for the first quarter of this year is an excellent example. Compared to a year earlier, the economy expanded by 18,3%. Excellent figure… until we look at growth compared to the previous quarter. Then it turns out that there is a slight shrinkage!
Back to inflation. The strong statistical effect I was just talking about does not play a role in the monthly figures. It is therefore the monthly figures that help me estimate the underlying inflation. This allows an assessment to be made on that important issue, namely whether the recent increase shows structural features.
If that is the case, monetary depreciation in 2022 could well be higher than central banks such as the Fed or the ECB now expect. That in turn may, in due course, force the Fed to talk about an exit from the very accommodative policy at the moment. This may lead to uncertainty about the central banks' policies on the financial markets. And speculation about a less loose monetary policy next year, something that puts pressure on stock prices.
Reopening the economy
In March, US prices rose 0,6% compared to February. That doesn't seem like much, but it is the strongest monthly increase since August 2012. With the reopening of the economy, the chance that retailers will increase their prices also increases. On the one hand to partially compensate for the damage suffered and on the other hand because they themselves have to deal with higher costs. This is evident from the increase in the producer price index (PPI) of 4,2% in March, the strongest increase since September 2011. Experience shows that there is a lag between the increase in the PPI and consumer inflation.
It is as certain that the annual inflation figures will be significantly higher in the coming months than we are used to, as that Ajax will become champions this year. With every publication on inflation figures, my attention is mainly focused on the monthly development of prices. Not that the Fed is going to make a different sound about future monetary policy, even if those monthly figures remain high. The party on the stock markets seems to continue for the time being, with new records in the offing.
But if those monthly figures remain high until the fall, for example, it will not be surprising if, towards the end of the year, some speculation arises in the financial markets about whether the Fed will maintain the set monetary course (in short: official interest rates for years to come). at 0%) can be maintained. That speculation could then put downward pressure on stock prices by then. This macroeconomist will therefore keep a close eye on the monthly inflation figures and the further development of the PPI indices in the near future.