Every investment cycle ends when investors get blind-sided by a macro/policy shock that undermines growth. The greater the froth heading into the shock, the greater the subsequent bear phase. Historically, the most frequent culprit has been a cyclical rise in inflation, which forces the Fed and other central banks to tighten policy by more than the economic weak links can withstand, triggering a recession and bear market in risk assets.
Last year, escalating protectionism looked like it might play the spoiler. However, President Trump ultimately backed-off before too much economic damage was done. Aided by the Fed’s U-turn (rate cuts), the financial markets came roaring back.
A provocative report from MRB last week highlighted the slow but steady rise in U.S. core inflation that has gone below most investors and the Fed’s radar. The underlying trend in both core CPI and core PCE is up, and both median gauges have moved above the Fed’s target level of 2%. While not a threat over the next six months, with the Fed unlikely to pull another U-turn before the November election, better growth this year and continued highly stimulative monetary conditions will set the stage for renewed Fed rate hikes down the road as inflation expectations awaken from hibernation. Today’s bond zealots, will give way to the long forgotten bond vigilantes. Stay tuned.