Navigating the return of inflation risk
For now, the mere re-emergence of inflation risk is the more pressing consideration for investors, not what inflation will be one or two years down the road.
- Inflation risks are tilted to the upside for the first time in at least a decade.
- We believe this changing balance of risks should prompt a rotation of flows away from growth stocks and other high duration assets and towards beneficiaries of firmer economic activity and price pressures.
- We continue to prefer procyclical relative value positions in earlier-cycle European, Japanese, and value stocks, and more recently EM ex-China equities. Yield curves should steepen, led by rising longer-term yields, while the US dollar weakens.
- Considerable uncertainty as to the persistence of inflation will remain in place through year end. This will add to its longevity as a market catalyst and spark bouts of cross-asset volatility over the coming months.
- The evolution of price pressures this year will not jeopardize the Federal Reserve’s patient, structurally dovish reaction function on rates.