Markets’ Next Bogeyman? Looming Inflation

Creeping inflation could be the next big swing factor in equity markets, particularly if central banks continue to inject more liquidity into the markets, a number of economists and strategists have warned.


“It’s Groundhog Day. We’re the definition of an idiot by Einstein – repeating the same experiment. That’s what central banks have reduced themselves to. We’ll never know what will happen if they stop because they continue to print, print and print,” Steen Jakobsen, chief economist, Saxo Bank, told CNBC Europe’s “Squawk Box” Tuesday.

He said he was “shocked” at price inflation in both the U.S. and China. Inflation in China rose 2 percent in August over the previous year on the back of weather-related increases in food prices, higher than the 1.8 percent in July. (Read More: Chinese Inflation)

Food price fears have been heightened around the world after extreme weather affected farming in the U.S. Midwest.

In China, there are also worries about foreign companies moving production back home, rather than outsourcing it to China because of the country’s rising wages.

The blame for risinginflation has been placed squarely at the feet of central banks’ and governments’ response to the financial crisis, particularly the focus on additional liquidity and bailouts of troubled economies and companies.

“The central problem is that there is $8 trillion of excess leverage in developed markets and $10 trillion more government debt today than in 2008,” analysts at Credit Suisse wrote in a research note.

“Thus, as above, we think we will get on-going synchronized QE [quantitative easing]. Central banks will have to print more money and this will continue to drive up inflation expectations.” (Read More: Roubini on QE3)

According to Credit Suisse, this could have a positive impact on equities, “given that inflation expectations are the main drivers of valuation multiples.”

The bank believes that equities could function as a “hedge on inflation” – until expectations rise above 4 percent.

Saxo Bank’s Jakobsen argued that the U.S. Federal Reserve should not announce the expected third round of quantitative easing.

“The Fed don’t need to do QE3 but I think they will. Doing nothing is what we need now,” Jakobsen said.

“They’ve done too much and got entrenched in the macro. We’re forgetting that the micro is doing well.”