Has inflation peaked?

US’ consumer price index rose by 8.5% year on year in July, below market expectations, on the back of lower energy prices. Risk assets rallied following the report as investors speculated that the Federal Reserve would soon temper its aggressive rate rises. The futures market is now pricing in 8 basis points less tightening by December1 and the bond market is pricing Fed rate cuts by February 2023. Investors appear to be positioning for a pivot in the Fed’s monetary policy. Over the last three weeks, there have been inflows into US bonds following sustained outflows since January. There have also been five weeks of continuous outflows from Treasury Inflation Protected Securities (TIPS)2 and commodities.

We previously indicated that inflation needs to peak, among other factors, for equities to have a sustainable rally. That said, the Fed would need more than one month’s inflation data to sound the victory in its fight against inflation. Easing supply chain disruptions and slower global growth would help moderate price pressures, as would the base effect.

On the other hand, food and rent costs are likely to remain high. It would also be important to monitor wage growth with labour costs being the largest cost component for US businesses. On balance, inflation may moderate going forward but remain higher than pre-COVID levels.

Historically, the trajectory of inflation has mattered more than the absolute level. Markets have delivered positive returns when inflation is elevated but falling. See chart. Between 1970 and 1984, during periods when US headline inflation was above 3.5% and falling, the S&P 500 delivered positive returns more than 67% of the time, with average 3-month median returns of 3%.

Eastspring’s Multi Asset Portfolio Solutions team retains a relatively cautious stance towards equities. Within equities, we continue to focus on strategies with attractive valuations and strong fundamentals. Value stocks encompass both these characteristics and have the additional benefit of light positioning. Meanwhile, as we wait for inflation to turn down more convincingly, low volatility strategies can provide investors a less bumpy exposure to equities.

Inflation regimes and S&P 500 median 3-month returns (1970 – 1984)

Potential to benefit from a Yen rebound

Source: BCA Research. 2022.

Sources:
1 As of 16 August 2022.
2 As of 11 August 2022. The Flow Show. Bank of America.

This document is produced by Eastspring Investments (Singapore) Limited and issued in:

Singapore by Eastspring Investments (Singapore) Limited (UEN: 199407631H)

Australia (for wholesale clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore, is exempt from the requirement to hold an Australian financial services licence and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Australian laws

Hong Kong by Eastspring Investments (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.

Indonesia by PT Eastspring Investments Indonesia, an investment manager that is licensed, registered and supervised by the Indonesia Financial Services Authority (OJK).

Malaysia by Eastspring Investments Berhad (531241-U).

Thailand by Eastspring Asset Management (Thailand) Co., Ltd.

United States of America (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is registered with the U.S Securities and Exchange Commission as a registered investment adviser.

European Economic Area (for professional clients only) and Switzerland (for qualified investors only) by Eastspring Investments (Luxembourg) S.A., 26, Boulevard Royal, 2449 Luxembourg, Grand-Duchy of Luxembourg, registered with the Registre de Commerce et des Sociétés (Luxembourg), Register No B 173737.

United Kingdom (for professional clients only) by Eastspring Investments (Luxembourg) S.A. - UK Branch, 10 Lower Thames Street, London EC3R 6AF.

Chile (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Chilean laws.

The afore-mentioned entities are hereinafter collectively referred to as Eastspring Investments.

The views and opinions contained herein are those of the author, and may not necessarily represent views expressed or reflected in other Eastspring Investments’ communications. This document is solely for information purposes and does not have any regard to the specific investment objective, financial situation and/or particular needs of any specific persons who may receive this document. This document is not intended as an offer, a solicitation of offer or a recommendation, to deal in shares of securities or any financial instruments. It may not be published, circulated, reproduced or distributed without the prior written consent of Eastspring Investments. Reliance upon information in this document is at the sole discretion of the reader. Please carefully study the related information and/or consult your own professional adviser before investing.

Investment involves risks. Past performance of and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the funds managed by Eastspring Investments.

Information herein is believed to be reliable at time of publication. Data from third party sources may have been used in the preparation of this material and Eastspring Investments has not independently verified, validated or audited such data. Where lawfully permitted, Eastspring Investments does not warrant its completeness or accuracy and is not responsible for error of facts or opinion nor shall be liable for damages arising out of any person’s reliance upon this information. Any opinion or estimate contained in this document may subject to change without notice.

Eastspring Investments companies (excluding joint venture companies) are ultimately wholly owned/indirect subsidiaries of Prudential plc of the United Kingdom. Eastspring Investments companies (including joint venture companies) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America or with the Prudential Assurance Company Limited, a subsidiary of M&G plc (a company incorporated in the United Kingdom).