Markets have recently been unnerved by the prospect of resurgent inflation in the US and a consequent rise in interest rates by the Fed. Clearly, the speedy vaccination campaign and Joe Biden’s fiscal stimulus will boost economic growth, suggesting some difficult decisions ahead for central bankers. At the same time, Jerome Powell is adamant that the Fed will not change course any time soon.

More than one American in ten has been fully vaccinated against Covid-19, the USD 1,400 cheques have started to be sent out, and spring is here. Summing up its monetary policy meeting on Wednesday, the Fed announced that it expected growth and inflation to accelerate significantly this year. It also revised its GDP growth forecast to 6.5%, representing the best performance since 1984, and sees the unemployment rate slipping to 4.5%.

Inflation is becoming more and more the dominant investment theme. In Google searches, the word is as common as in 2008. In the opinion polls, older respondents are eager to see a pick-up in inflation as opposed to the younger age bracket. In a recent report, the University of Michigan sees inflation clocking in at 2.7% compared to 2.3% 12 months ago. The Philadelphia Fed Manufacturing Activity Index for March rose to 51.8 points, up from 23.1 points in February, marking its highest level in 50 years. Production costs have shot up and the market is concerned about whether this is a blip or something longer-lasting.

The Fed wants to avoid a premature and excessive reaction to higher inflation, which would be due to a base effect that will gradually peter out. The Bank of England is taking the same approach and keeping its policy nice and accommodative. At the moment, most central banks are allowing inflation to overshoot their targets temporarily. A few others are pulling in a different direction. In Brazil and Turkey, the central banks have been tightening, while the Bank of Japan is slightly increasing its long-term yield band and cutting back on ETF purchases.

These events have shaken up bond markets and led investors to dump US Treasuries in particular. Last Thursday, the 10-year yield rose above 1.70% for the first time since January 2020. Fears that the Fed will lose control of the yield curve are hurting tech and growth stocks, which are richly valued relative to their earnings potential. The Nasdaq 100 handed back all of last week’s gains to retrace below 13000 points. The Dow Jones has been less affected, benefiting from the upswing in banking stocks, egged on by higher interest rates. European indices have also been gaining thanks to their more cyclical composition, clawing back much of the lost ground relative to other regions.

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