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LGT Beacon: Peak growth to douse inflation scare

July 14, 2021

Equities remain buoyant, while interest rates have declined markedly, despite the occasional brief flare up of market volatility. Today, we examine the underlying macro trends and argue that the current inflation scare is probably peaking along with the economic recovery's momentum – an outlook that should ultimately put financial markets in a sweet spot.

Since the later part of 2020, we had welcomed the surge in US inflation expectations above 2%, viewing it as a benign harbinger of a robust reflationary economic recovery. Today, we argue that the initial phase of that recovery has run its due course. Hence, inflation expectations are in the process of peaking and should moderate going forward. Consequently, we believe the short- to medium-term inflation expectations should also continue to retreat from their recent highs, while the long-term outlook, represented by red line in our graph, should move sideways around the 2% mark, i.e. the targeted average annual inflation rate.

Admittedly, this process may cause some interim market volatility as income data will produce some noise and investors gradually adjust to the new macro environment parameters. However, this process should also ultimately put risk-asset markets in a sweet spot – i.e. a macro regime characterized by broadly on-target inflation, and decent economy growth. 

Four recent developments make our case for a continued retreat of potentially excessive inflation expectations:  

  • Ordinary consumers' inflation expectations are already very high, which is typically a counter-indicator
  • The cyclical rebound in the West is peaking
  • The credit tightening in China continues
  • There is plentiful slack in the US labor market
  • The Federal Reserve is already acting to douse excessive short-term expectations without abandoning its broader accommodative policy goals

Admittedly, pandemic-related distortions will continue to play a role as the economy reopens and lockdowns might return to some degree, which would complicate this process, as would commodity prices if they continue to surge into next year.

Read on by clicking the link here: LGT Beacon

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Note: The next edition of the LGT Beacon is scheduled for August 2021.