Here's why the spike in inflation in the US may worry markets in India ⁠— but experts say don’t panic yet

Advertisement
Here's why the spike in inflation in the US may worry markets in India ⁠— but experts say don’t panic yet
Pixabay
  • The simplest explanation for high inflation is that there is too much money chasing fewer goods and services.
  • The fear in India is that if the inflation rate in the US rises beyond a point, the interest rate may also have to rise.
  • On one hand, inflation is rising sharply in the US. On the other hand, more Americans are looking to return to work but not finding jobs.
  • So, some experts, including Mohamed El Erian, the chief economic advisor at Allianz, believe that the US Fed may not move to curb inflation soon.
Americans have never seen the kind of a price rise, as they did in April, since 2013. The consumer price index increased 4.2% compared to the same time last year while economists were expecting the spike to be 3.6%.

Even a developing economy like India has seen a similar rise in consumer price index last month. Therefore, this kind of a rise is too high for a developed economy like the US.

The fear in India is that if the inflation rate in the US rises beyond a point, the interest rate may also have to rise. Central banks hike interest rates when inflation spikes to reduce the money jostling around in the system. If a cut in interest rate is an economic stimulus, a hike in rates is the exact opposite.

Advertisement
So if the markets expect the rates in the US to rise sooner than later, a big chunk of the foreign money parked in the Indian share market and bonds may head to the US because investors can get a better return for lesser risk compared to an emerging economy like India. However, some experts say, it may be too soon to reach that conclusion.

The biggest fear is whether the US Fed is reading the situation wrong

Jerome Powell, the Chairperson of the US Federal Reserve, has promised to keep an “accommodative stance” despite the unusual price rise in recent months because the American central bank believes that this is a phase triggered by pent-up demand and this too shall pass.

Advertisement

But many observers fear the price rise may be more durable given the pace of economic recovery in the world’s largest economy. William Dudley, the former president of the Federal Reserve Bank of New York, has already declared that the markets are in for an interest rate surprise.

"The fact is that when we factor in all the monetary and fiscal stimulus that's been delivered (or shortly will be), the Covid crisis seems likely to be a net inflationary event, at least in the near term," said investment management firm BlackRock's Rick Rieder.

Should the US continue pumping money into the economy?

The simplest explanation for high inflation is that there is too much money chasing fewer goods and services. But in the US, the government and the Fed are in the middle of pumping more money ⁠— a $1.9 trillion package was approved in March 2021 ⁠— in the US economy to stimulate growth.
Advertisement

So if there is already enough and more money circulating in the US economy, should the policymakers slow down the stimulus?

Mohamed El Erian, another leading global economist, has been warning about inflation in the US for a while now. However, El Erian, the chief economic advisor at Allianz, does not think the latest inflation data in the US is decisive. According to him, one should not extrapolate data for one month to project a possible policy change.


Advertisement
More people are buying used cars and trucks

There are others who also believe that the headline inflation in the US is skewed by certain components that do not reflect a broader trend. “US core inflation (which leaves out energy and food items) moved up by 90 basis points (bps) month-on-month, of which 30 bps was 'used vehicles' alone and another 10bps comes from airfare. Clearly, they do not qualify as signals of an overheated economy but rather of pent-up demand coming into play,” an Edelweiss Wealth Research report said.

The US jobs data can be a big hurdle en route to interest rate hikes

Not everyone in the US is recovering from the economic setback, brought about by the COVID-19 pandemic, at the same pace. The jobs growth in April for instance was a million short of what analysts had predicted.
Advertisement

Moreover, it is not because all Americans who are getting cheques from the government to survive the jolt are sitting back enjoying the freebies. Latest data has shown that more American are looking to return to work and more are getting classified as ‘unemployed’.

"That's the biggest fear we have because what we don't want is a jobless recovery," El-Erian said in a television interview. "There's a massive question mark as to how many will actually be able to get jobs again, or be willing to get jobs again."

Now, it is difficult for prices to continue rising if people’s purchasing power is capped. Politically, it may be difficult for US President Joe Biden and Powell to slow down the stimulus if enough people are still not able to find jobs and fend for themselves.
Advertisement

However, unlike the policymakers in the US, the market may not choose to wait for more concrete data. The market holiday on Thursday in India may help to stall the knee jerk reactions. Yet, Friday’s (May 14) trade in India will be interesting to watch. Traders would have two days of reactions from Wall Street to analyse before taking positions.


SEE ALSO:
WhatsApp responds to privacy criticism by alleging that other apps and tech companies also show disdain for user privacy
Vodafone Idea shares up by 10% as it adds subscribers for the first time in 15 months – Airtel, Reliance Jio expand their user base
{{}}