Last week saw important news-flow which can help inform us as to the outlook for inflation, monetary policy, and the course of financial markets.
Inflation expectations data (survey of expected inflation over the next year) remained at a series-high of 4.8% for the US, following a substantial jump last month, while expectations for inflation over the next three years rose to the highest level since August 2013.
The US Senate passed a new $1 trillion infrastructure bill, which includes $550 billion in new funding for transportation, broadband, and utilities. The Senate additionally took an important step forward in approving a broader $3.5 trillion spending plan which Democrats hope to pass (albeit, without Republican assistance) in the coming months. Fiscal stimulus of this magnitude hitting the economy in 2021-2022 will support growth but will also be inflationary.
The latest jobs report release showed that the US economy added 943,000 jobs in July, much higher than the 845,000 economists expected. The unemployment rate fell to 5.4% (below estimates for 5.7%), while, at the end of June, the number of job openings rose by 590,000 to an all-time high of 10.1 million. Jobs data is an important variable to watch since politicians and central bankers are united in their focus on the labour market as a primary indicator in determining monetary policy.
The above are all connected. Rising inflation and inflation expectations, fiscal stimulus potentially boosting inflation further, and strong US jobs data, all point toward monetary policy becoming less accommodative sooner rather than later. That matters because monetary policy support has been so important to financial markets in the recovery from the COVID-induced volatility of 2020.
The good news for investors is that this is happening in an environment of strong positive economic growth. Investors should, however, be conscious of the potential for higher volatility and divergent performance. More restrictive monetary policy and eventually higher interest rates, driven by a strong economy, is good for most, but not all stock valuations. ‘Hype’ stocks with their eye-watering valuations, to be found across multiple sectors (Tesla, bitcoin, et al.), could be the likely victims.
Stock picking and a focus on buying quality, growing businesses, at reasonable valuations has been a good strategy in the past and will remain so in the future, especially in a future of higher inflation and more restrictive monetary policy.
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