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CROSS ASSET WEEKLY
22.01.2021

Monitoring the Rebound in Inflation

Summary
Cross asset weekly pic
Financial markets are once again in a Goldilocks-scenario: expansionary fiscal policy and high household savings trigger expectations of a strong rebound in economic growth once COVID-related restrictions can be lifted. Central banks are holding policy rates low, are dampening nominal bond yields through their asset purchases and are constraining future rate hike expectations through their forward guidance. No surprise that equity markets are celebrating one all-time high after another. But can this last? It very much depends on how fast and persistently inflation rates will rise from their depressed levels again – a topic we have been analysing this week. Some rebound of inflation rates can be expected this year as oil prices are increasing again, demand for manufactured goods is solid and phasing out lockdowns would also lead to a rebound of prices in those parts of the services sector that has remained locked down so far. This will lead to higher consumer prices this year and should lead to somewhat higher inflation expectations in bond markets. Central banks, however, will not react to a mere short-term rebound due to base effects and oil prices. They would like to see permanently higher inflation rates around their 2% targets. This can hardly be assessed in the coming months – which is why we believe that financial markets are safe for now. Still, we analyse different combinations of economic growth and real interests to assess possible equity market developments – using the S&P 500 as an example. We show that our 2021 S&P 500 target of 4100 is on the cautious side by providing sensitivities for different GDP growth/US TIPS yield combinations. On the downside, it would require GDP growth to be quite a bit lower than expected to end the year below 4000. On the upside, if real rates were to remain at current levels, and GDP grows by 6%, the S&P could easily move above 4300.

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