An Exclusive Sneak Peak at What's Next for Inflation

How much will inflation grow?

US inflation hit a 40-year high in December and rising yields helped value stocks outperform their growth rivals. The analysis by Richard Flax, Chief Investment Officer, Moneyfarm

US inflation reached 7% year-on-year in December, the highest level in nearly 40 years. 

In response, in the short term, the 10-year yield on US government bonds fell and stock futures appreciated. At first glance, this would not seem like the obvious reaction from the market.

A bit of context: in recent months, inflation has been higher than expected, for longer than many hoped. 

This has recently sparked a reaction from central bankers: the Bank of England has raised rates and the US Federal Reserve is expected to raise them as early as March: this has pushed the US 10-year yield up. 

The rate remains low, but the spike was quite sharp and this contributed to putting some pressure on growth stocks.

Rising yields helped value stocks outperform their growth competitors. The graph below shows the relative performance of US value equities versus growth stocks, relating everything to movements in the yield on 10-year 10-year stocks.

The chart below shows the long-term trend: the 15-year outperformance of US growth stocks ties in quite well with the low rate phase.

What can this report tell us about inflation today? We believe there are a couple of related variables to consider. 

First, have we peaked in inflation or will price growth decline from here on out? Second, now that central banks have started to move, how aggressively will they act? If the Fed raises rates four times this year (by 100 basis points), would that end up slowing the US economy dramatically?

One possible interpretation is that we are close to the peak of inflation in the United States, partly because of base effects and partly because the Fed will begin to withdraw stimulus perhaps a little faster than might have been expected a few months ago. 

From this perspective, the inflation we see today is high, but not higher than expected, and this could be enough to signal the end of the inflationary surprises. 

In such a scenario, the Fed may not raise rates as often as many expect this year, which could provide some support for growth stocks.

It is always difficult to draw too many conclusions from a single data, but if this thesis is correct, we think this scenario is largely positive for equities. 

As always, we will continue to monitor data in the future, particularly on the labor market, which will likely play an important role in determining the course of inflation.