JPMorgan CIO says inflation is now the market’s key driving force


Traders work near the end of the day on the floor of the New York Stock Exchange in New York, U.S., February 8, 2018. REUTERS/Brendan McdermidThomson

  • Bob Michele, chief investment officer for fixed income,
    currencies and commodities at JPMorgan Asset Management, tells
    Business Insider inflation expectations are key to the market’s
    fortunes. Michele manages $470 billion in
  • Michele believes equity markets can absorb rising bond
    yields — barring an inflation spike that makes Treasury rates
    jump more quickly than foreseen.
  • Ongoing monetary easing from the European Central Bank
    and the Bank of Japan could provide some downward pressure on
    bond yields.

Wall Street’s sharp recovery in the last
two trading sessions
has done little to assuage investors’
concerns that the sudden spurt of market volatility that began
just over a week ago is here to stay, with all of the dangers it

For Bob Michele, chief investment officer for fixed income,
currencies and commodities at JPMorgan Asset Management, there is
one thing that could turn what he sees as a needed market
correction into a deeper equity-market funk: A sudden spike in
inflation expectations. 

“What panics the market is rising inflation expectations,”
Michele told Business Insider. 

“So if you see a sharp rise in prices, whether it’s the core CPI
[consumer price index], personal consumption expenditure, or
wages, people will immediately look to the central banks and the
Fed in particular to accelerate their tightening.”

Indeed, a stronger-than-expected 2.9% rise in annualized average
hourly earnings in the monthly
jobs report released on February 2
was likely a major reason
markets first went into a tailspin

The reason inflation expectations and wages hold such great
importance for stocks is because of their impact on Federal
Reserve policy — Fed officials see inflation expectations as a
harbinger of future inflation that could require tighter monetary

Many investors now fear that the combination of a tax cut package
on top of an already fairly robust underlying economic recovery
will unleash the inflation that’s been missing from the US
economy for the last several years, forcing the Fed to raise
interest rates more quickly than expected.

Already, investors have jumped from pricing in just two more
interest rates hikes from the Fed this year to as many as four,
possibly more.

The market’s tug-of-war

Barring an unexpected spike in inflation or expectations thereof,
Michele is actually fairly sanguine about the outlook for
financial markets.

“We think the global economy is in pretty good shape: Inflation
is picking up a bit, and the central banks are going to be gentle
in how they normalize because they don’t want to cause a
recession,” he said. Michele is urging clients to “take advantage
of the correction, maybe let it run its course a little longer.”
(The interview took place on Friday, before the market’s latest

Michele said he’d already dipped back into riskier assets by
purchasing small- and mid-sized industrial company shares,
banking and finance stocks, and convertible bonds.

“From our perspective, corporate credit looks great. None of us
can remember a time when corporate America has had more financial
flexibility,” he said.

“Since the financial crisis, companies have stripped costs out of
their operating model and have been operating a very lean and
efficient platform,” Michele added. “But now it’s got this
enormous tax windfall that’s coming which leaves a considerable
amount of after-tax income for companies to spend.”

Foreign central banks keep the cash flowing

Another driver of the stock market’s slump was a steady rise in
Treasury bond yields. But Michele believes ten-year rates,
currently trading around
a four-year high 2.9%
, will not rise much further above a 3%
to 3.25% range. 

10 year yieldAndy Kiersz/Business Insider

That’s because of his expectations for continued strong corporate
earnings, but also a less widely advertised source of demand for
risky assets that could hold US yields down — spillover from
continued monetary easing in Europe and Japan.

“I think we’re pretty close to topping out on the ten-year for
the time being. If we’re right the equity market can absorb all
of that with great ease,” he said.

“The other thing to remember is the ECB and the bank of Japan are
still printing money right now. […] And the Bank of Japan this
time next year very well could still be printing money.”

“We just see from our position the flow of money coming in from
Asia and Europe into the US market,” as US Treasurys continue to
offer higher returns compared to their European and Japanese
counterparts despite firming overseas growth.

“Those are the kinds of things that will cushion the backup in
yields in the US,” Michele said.

2018-02-13 06:57:00

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