The writer is director of group investments at Amundi
The bond markets are firmly in the driver’s seat. Rising yields as a result of the accelerating economic recovery are indicative of a pick-up in inflation. They will also stimulate the return of the valuable investment.
For too long, inflation has been off the radar of investors. So it’s tempting to view its recent rise, mostly in the United States, as a mere technical rebound in food, oil and manufacturing input prices from their drop at the start of last year’s lockdowns. But investors would be wise to take this story with a pinch of salt.
Indeed, various structural forces can be extremely important in hindsight. Major ones include a hostile environment for trade and globalization, government support programs for businesses and workers, and the extraordinary debt burden fueled by the pandemic. These should soon create a turning point in the current market regime.
More importantly, inflation is now desirable as a way out of the crisis by reducing the value of debts over time. A year ago, central banks and governments were forced to take unprecedented real-time action to avert a 1929-type depression. The resulting surge in debt will undoubtedly weigh on future generations. , but, for now, it seems the only game in town is to restart national economies by making them even more addicted to debt.
In order for this whole house of cards not to collapse, growth and inflation must be restored. This is the only way to pay off the debt legacy of the crisis. This is precisely why figures like US Treasury Secretary Janet Yellen and Federal Reserve Chairman Jay Powell downplay the importance of the recent rise in inflation – but not for long.
As its vaccination schedule accelerates, the U.S. economy will most likely be heading for a full reopening by the summer. The 2008 financial crisis depressed aggregate demand for an extended period. In this crisis, we can see the opposite. Personal savings rates in the United States are at levels not seen since the mid-1970s. In addition to large stacks of cash on corporate balance sheets, they are awaiting a green light signaling the end of lockdowns before they move on. get into a spending spree. This, at a time when the virus has also damaged the economy’s supply through disrupted supply chains and business closures.
If we add to that the multibillion-dollar additional infrastructure package proposed by the Biden administration to address the weak labor market, which will eventually be funded by cost-escalating carbon tax hikes, inflation is poised for a resurgence.
At the onset of the crisis, the Fed’s bold action – including large-scale public debt financing – was timely. Now, it’s hard not to see that this will lead to a de-anchoring of inflation expectations and a revival of the specter of 1970s-style price growth.
A change in market regime often occurs with a change in the mandate of central banks. The focus on inflation targeting that began with the arrival of Paul Volcker as head of the Fed in 1979 is fading. This is clear from the new priorities recently adopted by two central banks: ensuring full inclusive employment by the Fed and reducing global warming by the Bank of England.
For investors, this means that the rise in bond yields may not be over yet, but its speed may slow. Consider the tantrum taper of 2013 in bond markets that followed signals of reduced support from the Fed. More than two-thirds of the correction took place in the first three months. We believe it might be the case again, with the rest after the summer, once economic data reveals the true health of the US economy and its inflation trajectory. The role of the Fed in distorting asset prices is expected to diminish as market forces reassert themselves.
When that happens, expect further gains in so-called value stocks – companies seen as undervalued relative to their assets or earnings. The first part of a multi-year rotation to value took place in November following the positive announcement of the vaccines. This resulted in a simple revaluation of value stocks from their very depressed levels. Like the recent rise in inflation, this is not just another problem.
In the long-awaited moment of the vengeance of value stocks, investors should pay attention to cyclical names in Europe or American companies that can benefit from technological transformation and energy transition.
The return of inflation could help ease the debt burden. But it will be hard to swallow as it arbitrarily transfers wealth from savers to borrowers. Investors should prepare for this shift by looking for value stocks rather than chasing new fads.
