HONG KONG -- Fears are growing that a global economic revival and pandemic-induced fiscal stimulus measures will lead to surging inflation, casting a cloud over financial markets.
U.S. consumer prices in April rose at their highest level in more than a decade, according to data on Wednesday. It follows a sharper than expected jump in China's index of producer price inflation, which measures so-called "factory gate" prices.
Market expectations of future inflation are also rising. The five-year break-even inflation rate -- a measure of what investors expect the rate to be five years from now -- on Tuesday reached 2.79%, its high mark since 2005. The 10-year rate climbed to 2.56%, its highest point since 2013.
While an increase in prices has been expected as the global economy recovers from the coronavirus pandemic, economists are divided on whether the current trend is structural or transitionary. Investors are also parsing data to pick winning strategies.
Here are five things to know about the impact of inflationary expectations:
Why are inflation concerns rising?
Indicators around the world have shown sharp price rises. In the U.S. on Wednesday, consumer price data for April rose 4.2% compared to a year earlier -- outstripping economists' expectations of a strong gain. It was the highest monthly number since 2008.
That followed a surge in producer costs in China, where the producer price index rose in April by 4.4% in annual terms, the most since 2017. Inputs from oil and metal to screws and packaging shot up, suggesting that manufacturers that have absorbed cost increases for months are now starting to pass it on to consumers.
Prices for raw materials are also climbing at rapid rates. Iron ore and copper hit record highs this week, sparking talks of a supercycle in which raw material prices remain higher than long-term averages for a prolonged period. Agricultural commodity prices have reached multiyear highs, and timber has also raced to a record, as U.S. sawmills struggle to meet demand for the homebuilding material.
A chronic shortage of semiconductors in some industries, after the swings in orders as a result of the coronavirus pandemic, has added to upward price pressures.
And labor shortages are another reason to fret. Last week's U.S. April employment report show that 266,000 jobs were added, well below economists' estimates of a gain of about 1 million. Closer inspection reveals that a tight labor supply, rather than job demand, is crimping growth. Job openings rose to 8.12 million in March, the highest level going back to 2000, according to the Labor Department's Job Openings and Labor Turnover Survey.
"We expect core inflation to start accelerating gradually and exceed 2% on a sustained basis in 2023, as rent inflation picks up further and the expected negative payback from health care and vehicle prices wanes," Nomura economist Lewis Alexander said of the U.S.
Why will this affect financial markets?
For the past year, one of the big drivers of markets has been the availability of very cheap money. Pandemic-induced stimulus measures dragged interest rates to historic lows and flooded markets with liquidity.
Low-interest rates tend to increase the relative attractiveness of buying shares. In particular, investors searching for returns have plowed capital into growth stocks in the technology, health care and sustainable energy sectors, hoping to gain from the long-term revenue potential.
Falling interest rates also stoked bond prices. Prices for bonds move inversely to yields.
Now investors are preparing for a new set of circumstances. They fear higher inflation will prod policymakers to raise interest rates to prevent economies from overheating.
U.S. Treasury Secretary Janet Yellen, a former chair of the U.S. Federal Reserve, sent ripples across financial markets last week when she said "interest rates will have to rise somewhat to make sure our economy doesn't overheat." She later said she was not forecasting interest rate increases by the Fed to rein in any inflation.
"Inflation pressure is unlikely to moderate any time soon," said Will Denyer, an economist at Gavekal Research. "On the contrary, it is more likely to intensify. This implies the rotation from growth to value stocks has further to run."
Why are tech stocks being particularly affected?
Among the biggest losers of the anticipated "rotation" from some investments into others are so-called "growth" stocks -- that is, those that attract investors because of the potential of their future earnings, not necessarily their earnings today.
Valuations for fast-growing technology stocks are particularly affected since so many of their forecast profits and revenues lie far out in the future. And these were some of the companies that did best from the abundant liquidity and interest in new technologies during the pandemic.
Backing young companies or nascent technologies, hoping they will turn into a blockbuster, is relatively attractive when money is practically free -- but the tables turn when cost of capital rises and investors become more discerning and risk-averse.
The Nasdaq 100 Index has lost as much as 7.6% from its peak on April 30, while the S&P 500 Index slipped 3.3% during the period. The MSCI China Information Technology Index has slumped 16% so far this year, with a regulatory crackdown also contributing to the decline.
That compares with a 3% fall for the broader MSCI China Index, which tracks mainland companies listed in China, Hong Kong and other markets such as American exchanges.
Are there investments that might benefit?
While investors are pulling out of growth stocks, and shortening the duration of their bond holdings, they are starting to prefer "value" stocks, seeing the comfort of robust near-term cash flows as more important than future earnings growth.
This is channeling money into some sectors that were relatively unloved during the pandemic, including financial services, manufacturing and others like travel that can benefit from the opening up of economies.
The MSCI International World Banks Index has surged 26% this year while the S&P 500 Industrials Index has climbed 17% so far in 2021.
If the Fed concludes inflation is here for good and starts to hint at tightening, the asset prices most inflated by easy money may soften, analysts say. Either way is positive for value stocks and possibly negative for the U.S. dollar, analysts say.
In Asia, Chinese energy, Korean tech, Taiwanese materials, consumer staples and Indian financials were among the outperformers during periods of inflation, according to a study by BNP Paribas. The consistent underperformers were commodity users and overleveraged sectors, according to the report.
Gold is also traditionally seen as a hedge against inflation. The price of the precious metal has climbed from below $1,700 per ounce in March to above $1,800, though it is short of its record high of above $2,000 an ounce last August.
What are policymakers saying?
In short, they are asking markets not to panic.
In the U.S., which has an outsized effect on the global economy because of the dominance of the U.S. dollar, Fed Chair Jay Powell has indicated the central bank is some distance away from withdrawing support for the US economy.
The Fed has said substantial progress would have to be made toward its goals of maximum employment -- the highest level the economy can sustain while keeping prices stable -- before it starts to reduce its massive program of asset purchases.
The Fed's mandate is to try to maintain inflation at an average of 2% over time. The central bank has put higher readings down to "transitory factors" and the fact that prices are rising from a low base, having been suppressed by the pandemic.
"If we see inflation moving materially above 2% in a persistent way that risks inflation expectations drifting up," Powell said last month, "then we will use our tools to guide inflation and expectations back down."
Following Wednesday's consumer price data, the White House Council of Economic Advisers said part of the uptick was a "normalization" of prices as the U.S. begins to emerge from the pandemic.
"For instance, airline fares rose by 10.2% month-over-month," the council said on Twitter, "but prices in that sector remain well below their pre-pandemic level."
Later in the thread, it added, "There will be months that come in below or above expectations as strong demand meets recovering supply. Recovery from the pandemic will not be linear."
After the latest U.S. jobs report, traders pushed out the odds of a Fed rate rise by three months from as early as December 2022. Before the report, investors were also betting the Fed would offer clues about tapering its $120 million in monthly asset purchases as soon as June 2021.