Inflation worries weigh

Stock markets are pretty flat on Thursday, with Europe broadly lacking any real direction all week and the US battling inflation risks that are weighing on sentiment.

The US inflation data on Wednesday was a massive blow, there’s no doubt about it. Combined with the jobs report on Friday and the employment cost index the week before, it paints a picture of an economy running hot and with widespread price pressures.

The Fed may ultimately prove to be correct in its judgment that pressures will ease naturally over time as they’re broadly driven by temporary factors. But how long can they afford to stand by and watch inflation dramatically overshoot their target? Are they really that confident in their assessment? The pressure is intensifying.

The view in the markets is increasingly becoming that the Fed will be forced to act long before they have indicated. The central bank can’t bury its head in the sand for much longer and may be forced to accept that earlier hikes will be necessary if higher pressures persist. The transitory narrative is starting to fall on deaf ears.

Central bank inaction on rate hikes has long been celebrated in equity markets, contributing to sky-high valuations that some have argued aren’t sustainable. But that may be changing and inaction may come to weigh on sentiment in the coming months if central banks are forced to aggressively deal with higher, more prolonged and widespread inflation.

UK GDP highlights difficulty for BoE

Unfortunately, policymakers are stuck between a rock and a hard place, as we are seeing clearly in the UK. The BoE has backed itself into a corner in many ways as it weighs up dealing with inflation early at the risk of choking off an already sluggish recovery fraught with strong headwinds, or supporting the economy and risk inflation becoming a greater problem next year.

The GDP data today is clear evidence of the challenges facing the central bank. Can it really justify raising interest rates at a time when quarterly growth fell to 1.3% in the third quarter? The country already finds itself behind most other major economies in making up lost growth since the pandemic – still 2.1% smaller than Q4 2019 – and expectations for the coming quarters aren’t particularly promising. Higher taxes, energy bills and inflation, on top of the end of various support schemes, will hit household disposable income and be a drag on the economy.

Bitcoin the inflation hedge?

It may feel like there’s plenty of momentum in bitcoin but it’s having real problems fully capitalising on it as it continues to dip in and out of record territory. The US inflation data was seized upon yesterday and drove prices back to new highs but it didn’t last long and it ended the day down 5%. Not ideal for an inflation hedge. Bitcoin is certainly showing signs of exhaustion but it wouldn’t be the first time it’s done that before managing to dig deep and surge once again. And you wouldn’t put it past it now.

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