Inflation in the U.S. and how it affects the markets

US Inflation Markets

Since the beginning of the year, data from the North American economy have been warning about a possible and considerable increase in inflation. Waves of rumors, and expectations in the markets. 

Since the beginning of the year, data from the North American economy have been warning about a possible and considerable increase in inflation. Even so, the April figures surprised the majority, creating waves of rumors and expectations in the markets.

Undoubtedly this is closely related to the Covid-19 crisis, and a consequent reactivation of the economy. But beyond the causes that originated this phenomenon, what most wonder is what effect this increase has on their investments.

Well, even though it may seem like a distant data, the truth is that US inflation can affect the economy and markets globally, affecting the world stock markets in the short and medium term. Now, in this article we are going to see how well founded are the fears of some investors and to what extent we could perceive the impact of inflation on our investment portfolio.

How does the rise in US inflation affect the stock market?

One of the aspects that generates the most fear of the increase in inflation is how the stock markets are affected, although a rise in prices in theory corresponds to an increase in nominal income, which would consequently boost the price of securities. In practice, it does not necessarily work that way, since there are many other factors that can add or subtract so that a rise in inflation translates into benefits or catastrophes for a given market or economic sector. Thus, each sector assumes a different reality in the face of inflation.

On the other hand, one of the aspects that the investment community brings the most fear are interest rates. The interest rate that impacts the stock markets the most is the federal funds rate. This is what banks pay when they borrow money from the central bank of the United States, Fed for its acronym in English.

Increasing this rate does not directly affect the markets, however, it creates a domino effect. Banks pass the increase on to the rates they charge their customers for borrowing money. This reduces the consumption of the general population, which undoubtedly affects companies. At the same time, the companies themselves are affected by their ability to finance their operations, which limits their expansion capacity, as well as the creation of new companies.

Thus, in one way or another, rising rates can impact a company’s earnings, which often negatively affects the price of shares. In this sense, the effect of US inflation arises because the Fed uses rates as a measure to control inflation. If inflation rises, the Fed raises rates.

When many companies experience declines in their stock prices, indices such as the Dow Jones or the S&P 500 decline. Growth expectations are lowered, stocks become less desirable, and different markets may contract or see increased volatility.

What can we expect regarding US inflation in 2021?

As we have commented, the end of the pandemic and the aftermath of the special policies during the health crisis, which included important monetary stimulus programs, have led to a scenario marked by inflationary pressures in the North American economy. There is a fear that inflation will pick up aggressively.

For now, consumer prices in the United States increased 4.2% in April compared to the same period of the previous year. Way above expectations. Added to this are bottlenecks in the production of certain goods and services, which by reducing supply could lead to an increase in prices.

Furthermore, considering that confinement reduced the rate of consumption, there is a group of people who, by continuing to earn income, have managed to accumulate money. With the lifting of the measures that prevented them from spending, that money will begin to flow in quickly, contributing to inflationary pressure.

Against this background, experts are divided into two groups according to their expectations: those who consider that it is a temporary rebound, a consequence of monetary policies and the context of the pandemic. And a second group who believe that the inflationary rise could last a little longer and have more aggressive effects that would lead the Fed to execute an increase in interest rates, which would represent a greater impact on the markets.

Everything depends, then, on whether this price increase will accelerate in the following months, will it last or will stabilize. Let us remember that, if it stabilizes, it could have a positive impact, since it assumes the hope of greater economic growth.

The sectors most affected by North American inflation

If there is a market whose performance stands out, it is technology. Even in the midst of the crisis, it did not stop reporting marked growth. Not for nothing is it one of the sectors that has managed to get the most out of the low rates of the last decade. Thus, given the possible increase in these rates by the Fed as a measure to control inflation, there is no doubt that technology companies will be among the most affected.

What is more, this sector has become so important that it has the ability to drag the main indices with it. In addition to this, the expectation that this scenario materializes can lead many investors to monetize their profits, which could result in the massive sale of positions.

The same could happen with sectors with high leverage, such as construction.

Fortunately, not all sectors are affected equally. Some show greater resistance, and some may even benefit from moderate inflation. These are potential areas to seek refuge at the sectoral level.

One of these is the energy sector, such as the oil and gas companies. Well, energy prices tend to go hand in hand with inflation rates. So these are very likely to do well when inflation rises.

Another example of this can be the metal and mining companies sector, especially those focused on gold. The same as some commodity companies.

Ultimately, the rise in prices at controlled levels is natural and healthy. Well, it is a sign of strength and economic development. If inflation picks up, equity prices could react unfavorably, but some sectors could better absorb the shock and others are even poised to benefit. This is why, the investor, must monitor the indices and have alarms turned on to be able to migrate to more defensive investment portfolios in case inflation accelerates, incorporate gold or companies that do not require cash or that can increase prices without losing the business is of vital importance to protect itself.