Inflation Overtakes CCP Virus as Biggest Risk for Investors: Bank of America

Inflation has displaced the CCP virus as investors’ top worry, as Wall Street looks beyond the pandemic to the effects of the tidal wave of stimulus and the unleashing of pent-up demand as the economy recovers, a new Bank of America survey shows.

The bank’s most recent Global Fund Manager Survey (FMS) indicates that while the CCP (Chinese Communist Party) virus was the biggest “tail risk” in February, that has been replaced in March by above-expectation rates of inflation.

Virus worries have fallen to third, behind so-called “taper tantrums” in the bond market. These are sharp selloffs triggered by worries about faster economic growth and higher inflation, driving the Federal Reserve to react by raising interest rates.

“This implies that global fund managers think vaccination will finally lead us to re-opening and that the extremely loose monetary policy in times of economic recovery is not without risk,” Jeroen Blokland, portfolio manager for the Robeco Multi-Asset fund, wrote in a daily analysis.

Of the 220 fund managers who weighed in for the survey, 37 percent said inflation, 35 percent said bond market panic, and fewer than 15 percent said the virus posed the biggest risk for investors. Far less worrying than those top three concerns were fears of a Wall Street bubble, higher taxes, or tighter regulation under the Biden administration.

Exacerbating inflation concerns are expectations that the Federal Reserve’s new policy of moving to a flexible, average inflation target means that the central bank will hold off on raising rates in order to let the economy run hot for a period of time and overshoot its 2 percent inflation target.

“The Fed’s balance sheet will continue to swell. Interest rates will remain low. And in doing so, the Fed will really help to continue to spur economic growth with the ultimate goal of generating a higher trend of inflation,” said Michelle Meyer, head of U.S. economics at Bank of America Global Research, in a recent note (pdf).

Meyer said Bank of America’s forecast is for the core personal consumption expenditure (PCE) rate of inflation—which excludes the volatile categories of food and energy—to edge higher through 2021 and beyond, but not yet reach the Fed’s 2 percent target.

“So we think for core PCE, we’re likely to end 2021 in the order of about 1.6 percent on a year-over-year basis. Probably get to just south of 2 percent by the end of 2022,” she said in a separate note (pdf).

“So still a low inflation environment, but one where we are making some slow progress and it will largely be a function of the trajectory of wages. So it’s keenly important to focus on the path of the labor market when trying to understand the trajectory of inflation.”

Experts widely expect inflation to gain steam this year, driven by massive fiscal stimulus and the reopening of the economy as the spread of the CCP virus slows. But continued weakness in the labor market is likely to stop price pressures from spiraling out of control.

The U.S. economy is still around 10 million jobs down compared to before the pandemic, while last week, another 712,000 Americans filed for unemployment, Labor Department figures (pdf) show.

Treasury Secretary Janet Yellen said in an interview on March 14 that any upward movement of prices will most likely be temporary.

“Is there a risk of inflation? I think there’s a small risk,” she told ABC in an interview. “And I think it’s manageable. Prices fell a lot last spring, when the pandemic surged. I expect some of those prices to move up again, as the economy recovers in the spring and summer. But that’s a temporary movement in prices.”

Yellen dismissed worries about sustained inflation.

“I absolutely don’t expect that. We have had very well-anchored inflation expectations and a Federal Reserve that’s learned about how to manage inflation,” she said, adding, “We have tools to address it,” presumably referring to the Fed’s go-to policy measure of raising interest rates.

A recent analysis by Oxford Economics supports the view that upward inflation pressures will be held back by labor market weakness.

“The Fed’s new monetary policy framework is being tested by rising expectations of faster economic growth and inflation. However, despite improvements in health conditions, vaccine dissemination, and significantly more fiscal stimulus, we don’t foresee a ‘large and persistent’ rise in inflation or quick recovery in the labor market. This means the Fed will maintain its very accommodative policy stance,” Oxford Economics analysts wrote in a post about inflation.

Some economists have warned that the massive fiscal boost from the series of pandemic rescue packages could lead inflation to surge above expectations.

“A lot of people believe that inflation in the U.S. is dead or, if not dead, in a state of suspended animation for the foreseeable future. They could be setting themselves up for an unpleasant surprise,” Bill Dudley, former president of the Federal Reserve Bank of New York, wrote in an op-ed in Bloomberg last December.

The Federal Reserve’s inflation “nowcast” model, which tracks the real-time inflation estimates, shows that the year-over-year PCE inflation rate had risen to nearly 1.7 percent on March 17 from around 1.27 percent on Feb. 25.

The Federal Reserve’s own economic projections estimate that core PCE inflation will rise from 1.4 percent in 2020 to 2.1 percent in 2023. This measure tracks the inflation rate for the entire year.