May was an ok month for investors as major equity indices rose modestly. In fixed income markets prices tended to either hold steady or rise, as interest rates held relatively steady and capital markets remained liquid.
There is optimism around the US economy as GDP is forecast to reach and eclipse pre-pandemic levels this year. That optimism is tempered by the specter inflation, both in wages and prices. The inflation discussion centers around labor force participation and supply chain shortages.
The key questions, in our view, are whether eventual expiration of enhanced unemployment benefits drives sidelined workers back into the marketplace and how long supply chain disruptions take to work themselves out. In markets that are mostly driven by supply and demand, which we believe characterizes many commodities and goods, we would expect Adam Smith’s invisible hand to do its job when supply comes back online. In markets with more distortions, like the labor economy, we would expect high wages to be stickier. We also note that over the past year US consumers have substituted goods for services. As reopening occurs, we would expect the share of services consumed to increase relative to goods and perhaps that impacts demand for goods as supply comes back online.
Recently, the Federal Reserve pulled forward their estimate of interest rate increases to late 2023. Our view is that a forecast of activity expected to occur two and a half years in the future is subject to so many variables and uncertainties that it is of very little utility. The Fed seeming to care about the prospect of inflation may be enough to spook investors, but there is a lot that can happen between now and the first rate hike.
