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Why the market is fretting about inflation again
Inflation fears are back to haunt the market resulting in renewed volatility in tech stocks and leading to a wider sell-off in global equities.
As Shares went to press the latest US inflation numbers were set to be announced (12 May), which could dampen or exacerbate concerns over rising prices depending on what level they come in at.
However, this is not about one month’s reading of consumer price inflation. This is an issue for the medium-term. Investors are worried about the evidence of an economy running hot – particularly in the commodity markets where the Biden administration’s large infrastructure spending plans in the US are likely to push up demand for industrial metals.
In another sign things could be overheating amid the stimulus-fuelled recovery from Covid, so-called factory gate prices in China were up 6.8% in April – the fastest pace in three years.
Technology stocks are particularly sensitive to inflation expectations and interest rates. This is because expectations of higher inflation and ultimately higher rates negatively impact the level at which the anticipated fast-growing cash flow from these firms is valued at today.
For example, ARK Innovation ETF – a fund tracking a basket of tech-themed companies with disruptive innovation – has fallen by a third in value since mid-February. Tesla is down 29% since the end of January.
The US Federal Reserve has stressed on several occasions that it has no intention of raising rates any time soon and is prepared to let the market run hot for a time in the expectation that any inflation will be transitory.
However, the market clearly still feels this position could be overtaken by events. The picture looked quite different on 7 May when the key US non-farm payrolls release saw its biggest miss relative to the consensus forecast since 1998.
Around 1 million jobs were expected to be added for April compared with the actual number of just 266,000. Equities reacted positively to this news – employment is a key factor in the decision making of the Fed so this weak reading led investors to conclude the central bank would maintain low rates and stimulus for longer.
This led to a slump in bond yields and saw growth-orientated tech stocks trade higher on the day. However, even this release contained a hint of inflationary pressures as many speculated the disappointing number had as more to do with a lack of available (or willing) labour rather than a lack of employment opportunities.
Were this trend to persist it would likely lead to wage increases and add to the mounting concern about inflation.