Look at Covid-19 vaccines to gauge inflation tantrum odds

With news of another Covid-19 vaccine on its way and optimism rising ahead of the end-year holidays, it looks like 2021 will shape up to be much better than 2020.

But one forgotten danger could spoil the party: inflation. Price rises are far from investors’ minds, but an ‘inflation tantrum’ could have devastating effects on various countries’ economies if they are not kept in check.

It may seem odd to think about inflation right now, when economies are kept on life support by huge stimulus packages (making up more than 20% of global GDP) and with so many businesses closed by the pandemic, leading to a sharp rise in unemployment.

But the signs are there. In November, global food prices hit a near six-year high, having increased for six months in a row, according to the United Nation’s food agency, the Food and Agriculture Organisation.

And house prices, although not an important part of what is considered inflation in central banks’ books (although they really should be) have been spiking in the UK and elsewhere, spurred on by the extraordinarily low interest rates all over the world.

Still, investors are in a partying mood. A net 78% of fund managers surveyed in Bank of America’s monthly survey expect corporate earnings to improve — an all-time high.

Optimism that we will see above-trend growth and low inflation surpasses that recorded during the recovery from the 2007-2009 global financial crisis and is just below its 2018 peak, which is “consistent with an uber-Goldilocks view,” according to Bank of America’s analysts.

Investors are adding exposure to consumer stocks, commodities and emerging markets, with 60% of those surveyed expecting emerging markets to be the best performer next year.

Fund managers positioning. Source: Bank of America

A net 89% of those surveyed expect stronger economic growth in 2021; 42% said companies should increase capital expenditure, while 44% still believe businesses should improve their balance sheet.

Overall, allocation to stocks and commodities saw the highest net overweight since February 2011, according to Bank of America’s survey, which was carried out between December 4 and December 10 among 217 panellists with $576 billion in assets under management.

Inflation expectations

But even if inflation is for now out of mind, it is not completely out of sight. Fund managers’ inflation expectations increased by four percentage points to a net 79% expecting higher consumer price inflation at a global level in the next 12 months.

Although this is the highest percentage since July 2018, only 10% expect inflation to be “a lot higher.”

Still, a record net 75% of investors expect a steeper yield curve. This percentage is higher than after the 2008 collapse of Lehman Brothers, the 2013 Fed Taper Tantrum and the 2016 presidential election in the US.

Whenever the wave of optimism sweeping through the markets begins to ebb, fears about inflation will come into sharp focus. This could be correlated with the evolution of the Covid-19 vaccines.

In the Bank of America survey, 42% of investors believe the vaccine will start to positively impact the economy in the second quarter of next year, whereas 28% think it will happen even earlier, in the first quarter; 19% think the positive effects will only start to be felt in the third quarter.

As stock markets are forward-looking, whenever it becomes clear that the world economy is reopening for good, it is possible that they will turn their attention to inflation. That’s when an Inflation Tantrum that could bring valuations down.