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Having been starved of negative news for much of the last two years, commentators have seized the opportunity presented by this week’s volatility. The most excitable are running with the story that inflation is back and central banks are behind the curve; as central banks scramble to regain control, interest rates will soar, putting an end to both the recovery and the rally in stocks.
Let’s look at each component of this story in turn.
First, is inflation back? Last week average earnings in the U.S. picked up 0.3% points to 2.9%. With the unemployment rate now at multi-decade low some recovery in wage growth was expected this year. Of course inflation is like a sweet treat – you want a little but certainly not too much. The scale of the uptick was noteworthy but there are some funnies in this number as the measured pay for some workers was affected materially by January’s cold snap. And the other inflationary data out last week were far from frightening. The U.S. PCE deflator eased to 1.7% still well short of the Federal Reserve’s 2% target. And in the eurozone inflation in January slowed to 1.3%, lower than market expectations. Global commodity prices – often the best gauge of whether the global economy is overheating – have also been easing in recent weeks. The evidence that inflation is back is simply not compelling, at this stage.
Second, will soaring interest rates send stocks lower? It is easy to understand why so many worry about tighter central bank policy given that when the central banks were pumping money in, markets went up a long way. But it is worth remembering that economies grow due to two forces. There are the natural organic forces in the economy; companies and households feeling good about the future, wanting to spend and invest. Then there are the artificial stimulants of fiscal and monetary policy.
This is very similar to how I operate. On days when I have had a great night sleep and been to the gym in the morning, I am very productive. By contrast, after a night where I have had a glass of wine or my children have been up in the night, it takes a double espresso to get me through the day. 
Since 2008, the central banks have been dealing with the most almighty of hangovers. The caffeine injection needed to be much larger, and sustained for much longer, to keep activity moving forward. But the economies are now rested. Households and businesses are feeling better about the future. They do not need a boost in quite the same way. Central banks can ease off the accelerator without troubling either growth or markets. Remember that in the last fifteen years there were ten episodes when the U.S. 10-year yields rose about 50bps, and 90% of the time, equities delivered positive returns.
Overall we are not convinced that the recent moves represent a major change of economic or market direction. Instead it is a normal shake-out that represents some portfolio re adjustment and profit-taking after a peculiarly strong start to the year. Some market volatility is actually quite normal; since 1980, the average intra-year decline for the S&P 500 has been 13.8% whilst annual returns were positive in 29 of those 38 calendar years.
Unless you believe inflation is really set to return in a meaningful fashion then you should be confident that central banks will ease off the accelerator but stay away from the brake. In which case, the outlook for risk assets remains positive.
Published by J.P.Morgan Assett Management
Author: Karen Ward. Chief Market Strategist, UK & Europe

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