Throughout 2021, markets have been pricing in higher inflation expectations. The Fed’s updated guidance allows for a more patient approach to reaching inflation and employment targets. The Fed will move to an average targeting regime allowing for inflation to overshoot its 2% target “for some time” – while being vague in communicating for how long or by how much inflation can move beyond their target before adjusting policy.
Understanding this dynamic, markets have gone through a repricing in order to compensate for the idea of higher, sustained inflation. Real rates in the U.S. moved higher in the first three months of the year, causing U.S. Treasuries to sell-off and growth equities to lose their luster in favor of cyclical sectors. We’ve seen the bulk of this story play out more recently. Five-year inflation expectations reached their highest level since 2006. Growth expectations have continued to push higher for 2021 and 2022, while Washington continues to add more fiscal spending. In addition, the April CPI report printed its highest year-over-year number of 3% since the mid-1990s.
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