The world appears to be comfortably on a path to recovery from the coronavirus pandemic, with a vaccine rollout underway. Markets have continued to creep upward toward record highs on this vaccine optimism and support from monetary and fiscal stimulus.

However, new fears have been voiced by market observers over the return of inflation. The same factors that are supporting the economy could also result in a quicker than expected return to pre-pandemic levels of activity, which has led to inflation expectations picking up in recent weeks. The threat posed here is that in a worst case scenario, central banks will have to quickly reverse their supportive policies to bring inflation under control, raising interest rates and ending or slowing asset purchasing programs. This could result in a policy mistake, where central banks cut back their support too early, derailing the nascent recovery. Another possibility is that we could see a similar result to the “Taper Tantrum” in 2013 when markets that had become too comfortable with low interest rates and easy money panicked over comments from the Federal Reserve (Fed) that it would soon begin policy normalization.      

At this point in time, we’d like to reiterate our view that inflation is currently not much of a threat to derailing the economic recovery or market performance. Moving out of the recession caused by the pandemic is bound to cause some uptick in inflation numbers due to base effects. Some inflation during recovery periods is perfectly normal and tends to go hand in hand with growth. A return of inflation would be a positive sign that the situation is getting better.    

Inflation is also unlikely to skyrocket. Most economies are still dealing with above-average unemployment rates, and the labor market is a long way from driving higher wages. Without higher wage inflation, demand is unlikely to be a major factor in driving prices higher.

Looking at the latest inflation numbers, most measures are still far from panic-inducing. In the U.S., price changes remain below Fed targets. More locally across Asia, the numbers are no cause for panic. Malaysia and Thailand are still seeing deflation, Korea and Taiwan hover around barely half a percent and China saw an unexpected inflation fall in January. Hardly worrying right now, even when we do expect a pick up later in 2021.

This still leaves the issue of what central banks will do. The possibility of a mistake due to policy error shouldn’t be ignored. We expect most central banks across Asia will lean toward caution and flexibility. They will be quite aware that a sudden surge in prices from pent-up demand is only temporary before moving to raise rates. 

Inflation expectations have been creeping upward, but actual inflation numbers show that price rises still have a way to go before becoming as issue
Exhibit 1: Keeping an eye on inflation

Source: Department of Statistics Malaysia, DGBAS, Eurostat, FactSet, Goskomstat of Russia, IBGE, India Ministry of Statistics & Programme Implementation, INEGI, J.P. Morgan Economics Research, Korean National Statistical Office, Melbourne Institute, Ministry of Commerce Thailand, Ministry of Internal Affairs & Communications Japan, National Bureau of Statistics China, Office for National Statistics UK, Statistics Indonesia, Statistics Institute Turkey, Statistics South Africa, U.S. Department of Labor, J.P. Morgan Asset Management. Quarterly averages, with the exception of the two most recent figures, which are single month readings, are shown. Colors are based on z-score of year-over-year inflation rate relative to each market’s own 10-year history where red (blue) indicates inflation above (below) long-run trend. EM represents emerging markets.
Guide to the Markets – Asia. Data reflect most recently available as of 17/2/21.

Investment Implication

Inflation fears are overstated, but they do exist. A rise in prices is expected this year, but it should be a sign of economies returning to normal and not a cause for panic.

Central banks could still make the wrong move, but we believe they are currently more willing to let the economy “heat up” rather than not letting it “heat up” at all and therefore will keep monetary policy loose and supportive. Most attention will be on the Fed, as the U.S. is still a major driver of what happens globally. We saw in 2013 during the “Taper Tantrum” that a mere suggestion of policy normalization and tapering can cause market panic. The Fed’s “average inflation targeting” framework does allow it flexibility, and it has stated it will be patient. In Asia, the situation, as always, is more varied. Countries such as India and Indonesia, which have to juggle issues with currency strength, capital flows and deficits, face more rate pressure. The key will be to watch liquidity conditions. We expect that central bank officials will be aware that due to the pandemic, many effects will be only temporary as consumers shift their behavior as economies move out of the pandemic. Central banks across the region will follow suit in being patient and move carefully.

For now, as we wait for growth and inflation to pick up, the implication of a return to normal is positive for risk assets. The steepening yield curve due to the rise in inflation expectations does suggest greater confidence in the recovery in the future. Banks and financials in particular should benefit from these developments. Yield curve steepening will benefit profitability at a time when rates are low and still unlikely to move for now.