Inflation? Nothing to be afraid of

US inflation is rising rapidly. For the time being, more attention is being paid to the words of policymakers in the financial and foreign exchange markets than to the hard economic figures.

If you just look at the numbers, it was quite a shock. US inflation made its biggest jump in more than 8 years in March: to 2,6% from 1,7% in April. In May last year, inflation was just above 0%. Inflation was also slightly higher than expected.

Under normal circumstances, a jump in inflation leads to unrest in financial markets. A rise that is too rapid often provokes a reaction from central banks. To keep inflation in check, they can raise interest rates. And that echoes through the financial and currency markets. Stock prices usually go down when interest rates rise. Companies are faced with higher financing costs and saving is becoming relatively more attractive.

Words outweigh numbers
On the other hand, the exchange rate of a currency increases with a higher interest rate. That was also the case for the dollar. The currency took off in the first quarter of 2021 with a gain of about 5% against the euro. In April, however, the dollar steadily loses ground. This week's inflation jump doesn't change that at all.

An important reason is that the financial markets are now more about words than numbers. Even before the publication of the official figures, 2 top economists of President Joe Biden already took the sting out of the sharp rise. According to Jared Bernstein and Ernie Tedeschi, there are 3 reasons why inflation may temporarily be higher than usual.

Temporary bump
In the first place, that is the basis for comparison. Last year, for example, the oil price was a lot lower as a result of the virus outbreak. This is a one-off effect that will no longer have an impact on inflation figures in a few months. Two other factors driving inflation now are catching up in consumer spending once the economy reopens and difficulties in scaling the supply chain such as the chip shortage.

Biden's advisers are forecasting inflation, after a temporary bump, to fall back toward the level the Federal Reserve is targeting. Fed Chair Jerome Powell is also strongly considering that scenario. He therefore does not miss an opportunity to emphasize that he will not raise short-term interest rates for the time being.

Good news for investors
A consequence of all these words is that long-term interest rates – which are established on bond markets – have recently been taking a step back. Since the end of March, the yield on US 10-year government bonds has fallen from 1,75% to 1,6%. It is no coincidence that movement coincides with the decline of the dollar. As long as financial markets are guided by words instead of numbers, the dollar will take a step back.

A low dollar is good news for investors. American companies – which represent almost 60% of the global stock market value – benefit from low interest costs and, thanks to a favorable exchange rate, make more profit abroad. Only if inflation remains high in a few months' time should we start to worry about how it will affect the stock market party.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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