Market Volatility

How Inflation Fears Are Shaping Sentiment

The heightened chatter over elevated inflation rates should help markets move on faster than most assume.

Inflation can take a toll, particularly for households on a fixed budget. For that reason, recently elevated readings—like Thursday’s 7.5% y/y US consumer price index rise—have many fearing for the future.[i] Adding to the gloom, inflation has become increasingly politicized—on both sides of the aisle—making it difficult for many to weigh its market impact. That is what we focus on, so what follows isn’t an ideological or political statement, but rather, something we think all investors should keep in mind: For markets, the question isn’t about when inflation moderates, how high it peaks or how the Fed handles it. Rather, the critical issue to remember is that stocks price in all widely known information, including widely held expectations. Seen in that light (and notwithstanding Thursday’s volatility), we think the vast, vast attention paid to January’s rise should help stocks: It further saps the shock factor, likely allowing markets to move on sooner than many seem to expect.

In our experience, volatility and widespread, frightening headlines often move together—and follow a recurrent pattern. It usually goes something like this:

  1. People fear thing X will happen and hurt markets.
  2. Thing X actually happens.
  3. Markets show some negativity, maybe even a correction (short, sharp, sentiment-driven -10% to -20% drop).
  4. This creates the mentality of, “Oh that thing happened and it hurt stocks. Since it happened, we can move on.”

This isn’t a conscious realization, mind you. It is more of an extension of confirmation bias. The person fearing X happening saw X happen and markets wobbled. That is validation, even if the wobbles weren’t as big as feared earlier.

Take 2015, a rocky year amid a decade-plus bull market. Then, fears rotated around a Chinese slowdown and another Greek default. Chinese growth actually slowed! Greece defaulted for the third time in four years! The S&P 500 fell -10.9% from August 18 to 25, then floundered through September.[ii] But by October’s close, stocks had moved back near pre-correction levels. Some Chinese and Greek fears lingered—but with their ability to shock drained. People saw the thing they feared having the impact they feared and, consciously or not, realized its power was spent. Stocks repeated that very feat at yearend, when long-lingering fears of a Fed rate hike finally materialized in December. Volatility ensued, but it was over in weeks—and stocks rebounded swiftly.

We are starting to see this with inflation. Stocks’ volatility since January has pundits beating the inflation drum ever harder. Today’s -1.8% S&P 500 drop is a case in point.[iii] The 10-year Treasury yield’s rise to just over 2%—with headlines proclaiming: “Highest since 2019!”—is another prime example. People are so focused on near-term swings that they seemingly forget 2% is about where long-term rates were just before the pandemic—a low level by historical standards.

Fed-funds futures are now pricing in a 50 basis point (half percentage point) Fed rate hike in March and several more after to get prices in check. We have noted before the Fed’s inability to address supply issues behind price increases—rate hikes won’t magically multiply primary residences to rent or own, fabricate semiconductors, build cars or refine more oil. Yet pundits now claim demand is too high and must be reined in. While we think that is misguided, the hype is allowing markets to pre-price this.

With more and more people expecting a 50 basis point Fed move, it is less and less likely to matter much to markets when and if it comes. That doesn’t preclude short-term volatility when the Fed acts, but it does set up a scenario where—once again—people build up fear of a thing, the thing happens, and then the fear loses its power.

Of course, fears may weigh on sentiment and spur short-term volatility, but what matters for markets longer term is how the expectations markets pre-priced square with reality. Are inflation and steep rate hikes great? No. But neither one is automatically bearish. They also aren’t catching anyone off guard. Surprises are what move markets most over time. At this point, what negative scenarios are out there that markets haven’t already sorted through?



[i] Source: BLS, 2/10/2022. CPI, January 2022.

[ii] Source: FactSet, as of 2/10/2022. S&P 500 total return, 8/18/2015 – 8/25/2015.

[iii] Ibid. S&P 500 total return, 2/10/2022.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.