Market Update – 26th May 2021.

The inflation outlook remains the big theme this week ahead of Friday’s US core PCE data release (the Fed’s preferred inflation measure).

While the PCE reading for April is highly likely to follow the recent US CPI inflation release and record a big jump, to us it will be very similar to much of the other recent data releases:  all noise and no signal thanks to the distortions caused by the impact of last year’s coronavirus outbreak and sudden lockdowns, coupled with today’s supply constraints caused by the economic reopening burst.

While all these inflation measures are, and will for the next couple of months, show some big increases, we continue to believe that it is transitory and therefore expect it to quickly fade as the distortions pass through, rather than result in persistently high inflation.

As an aside, it has been pointed out to us that the cost of items such as phones and cars keep increasing.  However, this is where we believe that inflation readings are actually overstating, rather than understating, the true inflation rate – as although the cost of a new smart phone or a car may be more than the previous model, these new phones and cars have more gadgets or safety features.

For example, the cost of a new car (or at least the amount we pay for one) may appear to be constantly rising, but would you sooner have a car with airbags and impact protection; anti-lock brakes; reversing cameras; central locking and an alarm; etc., or would you sooner go back and get the safety, security and accessories of a car 30, 40, or 50 years ago?

Consequently, while it may appear that we are paying much more for a new phone or a new car today than we used to do, that doesn’t mean there has been inflation in prices – we are simply paying for new and more expensive products and services.

Additionally, policymakers also appear to be looking past short-term higher inflation data:  the Fed Vice Chair, Richard Clarida, said inflationary pressures would be largely transitory, while the Chicago Fed President, Charles Evans, pushed back against the idea that any rise in inflation would be long-lasting.

Investment Management Team