Investors grappling with the shape of the Covid-19 recovery have the same blind spot as after the financial crisis: They don’t know how inflation works.
The S&P 500 hit new highs this month despite the devastating impact of the pandemic. Likewise, market inflation expectations have rebounded to their February levels, just months after hitting their lowest level in 11 years.
Below the surface, however, investors cannot decide how Covid-19 will affect consumer prices. Some fear deflation in an environment of weak demand, while others hedge against the opposite: the risk of a fiscal windfall from Congress and an aggressive monetary stimulus from the Federal Reserve – along with other major governments and banks. – could bring back the dangerous combination of inflation and unemployment that plagued the 1970s. The Federal Reserve’s decision to stop raising rates as a precautionary measure to ward off inflation, approved under of a new strategy Thursday, reinforces this last concern.
“The forces of inflation are lining up,” Morgan Stanley chief economist Chetan Ahya said in a recent note on the subject.
How this debate unfolds is important to your wallet. Signs of rising prices could have a particularly dramatic impact, as inflation has historically been associated with the outperformance of low-valued companies at the expense of “growth” ones, such as the tech stocks that propelled the stock market over the past decade. the last decade. Bonds would be hammered, even if the Fed is also cautious about rate hikes.