Second Quarter 2021: Inflation, So Hot Right Now
The word of the quarter was “transitory” as investors tried to decipher the root cause behind the highest inflation readings in decades. Despite some dire predictions about the return of stagflation and a 5.0% annualized inflation increase in May, the verdict of the market suggested that inflation may just be transitory. Interest rates and inflation expectations decreased and bonds, which had sold off in the first quarter, rallied back with longer-duration assets gaining the most.
The interest rate decrease in part stemmed from mixed messaging from the Federal Reserve. The Fed, which is now using a new flexible average inflation targeting framework, is trying to strike the right balance of monetary support for the recovering economy while avoiding a repeat of the 2013 taper tantrum, which undermined market stability. Market participants, interpreting updated Federal Open Market Committee projections, expressed some skepticism of the Federal Reserve’s tolerance for future higher inflation.
Meanwhile, even with consumers expecting higher inflation in the coming year, U.S. consumer confidence soared to a fresh pandemic high. The proportion of consumers planning to purchase homes, automobiles, and major appliances all rose in the quarter, which should provide support for the economy in the near term. Home sales have slowed as prices have risen in the year, with the S&P CoreLogic Case-Shiller residential home price index jumping the most in more than three decades. On the employment front, the share of consumers that said jobs are plentiful increased to a 21-year high, and respondents who said jobs were plentiful exceeded the share of those who said they were hard to get by the most since 2000.
The optimistic expectations provided a supportive backdrop for stocks, as virtually all sectors and regions gained in the quarter. The S&P 500 and NASDAQ hit all-time highs and growth shares were the market leaders in the quarter after lagging earlier in the year.