Written by Norman Isaac Mwambazi

Inflation scare is over, investors turn focus to the Federal Reserve

In the previous few months that have succeeded the passing of the $1.9 trillion stimulus package by the Biden administration …

In the previous few months that have succeeded the passing of the $1.9 trillion stimulus package by the Biden administration in addition to the $900 billion package that had been passed by the Trump administration to rescue the economy from the effects of the covid-19 pandemic, there have been growing fears of inflation amongst investors.

This is because the $1,400 stimulus checks millions of Americans received increased their purchasing power which in turn drove up consumer prices yet suppliers were still struggling with some hurdles in getting the supplied chain to what it was pre-pandemic. This has forced the companies to raise their prices with the rising demand for goods.  

The good news is that these fears seem to have been washed away because investors have digested the idea that inflation is currently running above previous expectations. The fear has now turned to the Federal Reserve Bank as investors wait to see how quickly it will respond to the rise in prices. The benchmark S&P 500 has been basically flat since mid-April, a stretch that included a 4% pullback.

Inflation regarding bonds

In the bond market, prices indicate that investors expect inflation over the next five years to be 2.62% annually, up more than 0.62% at the start of the year. However, this expected rate of inflation is lower than 2.7% where it stood on May 10, 2021.

Dennis DeBusschere, head of portfolio strategy research at Evercore wrote that “that inflation shock fear eased over the past week.”

Federl Reserve Bnk ction

Investors are now monitoring how soon the Federal Reserve Bank will respond to inflation. In the last year, the Fed has managed to keep interest rates at near-zero levels to keep the economy afloat through buying bonds, so the Fed’s first move is expected to reduce the amount of bonds it has been buying.

If the Fed does this, the money moving into the market will significantly reduce which would, in turn, reduce bond prices. This result will be an increase in both bond yields and the cost of borrowing for homebuyers and corporations alike. Higher yields also eat into the current value of future cash flows, bringing stock valuations lower.

The minutes from the Fed’s April 28-29 policy meeting, published last week, even raised the possibility that members may begin discussing scaling back, or tapering, the asset-purchasing program at coming meetings.

“In investors’ eyes, the taper signal timeline was pulled forward to July instead of August,” DeBusschere says.

The second move by the Federal Reserve Bank might be to raise the benchmark lending rate, an action that could come sooner than expected, considering it was expected to stay protracted until 2022 or 2023.

According to Evercore data, the futures market for the federal-funds rate is now reflecting a rate just under 0.25%, up from 0.2% a few weeks ago. The Fed’s current target range for the rate is between 0% and 0.25%.

Currently, investors are expecting interest rates across the board to rise sooner rather than later and this could soon led to significant stock-market volatility.