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What to Watch, Beyond Inflation

We think the critical issue – beyond inflation – in the coming months will be the successful passing of the baton from government stimulus supporting growth to private demand as the driver. Chief Investment Strategist Jim McDonald explains.

  • Dependable Growth
  • Benign Inflation
  • What We’re Watching



Investors look ahead at least six months discounting what they think are the most likely outcomes for growth, inflation, and other key inputs. We think the critical issues in the coming months, beyond inflation, will be the successful passing of the baton, from government stimulus supporting growth to demand as the driver. Let's take a closer look.

COVID-19 has increasingly become a non-issue to the financial markets as rising vaccinations lead to reopening in the US and Europe. Even struggling countries, like India and Brazil, have registered double-digit equity market gains. The current state of economic affairs features red hot growth and surging prices.

Growth hasn't been much of a worry, as high savings rates, low capital expenditures, and reopening have underpinned investor confidence. This has left plenty of attention to be trained on the outlook for inflation. And investors need to assess more than just forecasts.

While recent inflation of the US has surpassed forecasts, some may be puzzled by the benign reaction in the financial markets. The Federal Reserve expects inflation to be transitory. And we have regularly stated our view that prices will settle down after the reopening-led surge.

So far, at least, the markets are growing as the 10-year treasury yield and inflation break-even rates have steadily fallen in the face of the recent high reports. If inflation doesn't upset the apple cart, what might? It has become clear that is a lot easier to shut down a global economy than it is to reopen one.

Not only if bottlenecks created inflationary pressures, they could also slow growth as the supply of goods and labor falls short. Labor markets have shown a slower than expected return of workers, which constrains the growth outlook, but also extends the duration of easy monetary policy and economic expansion. This underpins our base case theme of a bumpy but shock-absorbed recovery.

Our other base case of a market laggard runway captures our view that prior lagging groups, like value stocks, have further to run. Our risk cases include the potential for higher than expected inflation, along with a dropped growth baton, where the rebound in consumer and corporate demand is insufficient to offset the lack of fiscal stimulus in 2022. All in all, we had no changes in our global policy model this month and remain overweight equities, natural resources, and listed infrastructure, with a commensurate underweight in inflation linked bonds and cash.

Jim McDonald

Chief Investment Strategist
Jim McDonald is an executive vice president and the chief investment strategist for Northern Trust. He is responsible for overseeing the strategic and tactical asset allocation policy for our institutional and wealth management clients globally.