Inflation fears are stoking volatility in stocks but they're unlikely to derail the market rally, says UBS

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Inflation fears are stoking volatility in stocks but they're unlikely to derail the market rally, says UBS
Lucas Jackson/Reuters
  • A jump in US inflation will stoke bouts of volatility in the stock market but it's not likely to stop the overall rally, says UBS.
  • Consumer price inflation for April soared by more than expected, to a rate of 4.2%.
  • "We think that the reflation trade has further to run, UBS said Thursday.

US inflation rates are flying up and worries about an acceleration in prices ranging from airline tickets to energy have knocked stocks off their record highs, but those fears are unlikely to derail the overall rally in equities, wealth manager UBS said Thursday.

The "latest volatility does not come as a surprise. But we also don't see it as signaling an end to the bull market," Mark Haefele, chief investment officer of global wealth management at UBS, wrote to clients.

The arrival of April's Consumer Price Index confirmed months of caution from economists who said stronger inflation was on the way, a reflection of ongoing economic recovery from the COVID-19 pandemic. The higher-than-expected headline and core inflation readings drove stocks sharply lower Wednesday.

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Market pricing of the inflation outlook also stepped higher, said UBS, noting the US 10-year breakeven rate moved to imply an average inflation rate of 2.56%, close to the highest level since 2013 and up from 2% when 2021 got underway.

The CPI data triggered Wednesday's selloff in stocks that left the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average each down by at least 2%, with the Dow industrials tumbling 682 points.

"The latest rise in inflation, in our view, reflects year-over-year comparisons, which will fade," he said. "While raw material prices may climb further, we believe the bulk of the rise in commodity prices is now over. In addition, labor supply headwinds should ease in the next few months once schools fully reopen, vaccinations continue to rise, and supplemental unemployment benefits expire."

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The CPI jumped to 4.2% from a year earlier, the largest increase since 2008, and core inflation, which strips out volatile energy and food prices, surged 0.9%, the largest one-month climb since 1982.

The UBS wealth management chief said it was important to note that major central banks have indicated they will not tighten policy in response to a temporary increase in prices. He outpointed that Federal Reserve Governor Lael Brainard said Tuesday the Fed will be "patient" as an inflation surge looks transitory.

"As inflation uncertainty persists, and as economic reopening remains on track, we think that the reflation trade has further to run. Our preferences include small-caps, financials, energy stocks, commodities, and emerging markets," said Haefele.

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Investors on Thursday appeared to set aside inflation worries, with Wall Street's key stock indexes riding up roughly 1% each after weekly jobless claims hit another pandemic-era low.

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