With covid cases trending upwards once again, the likely driver of GDP growth over the next few quarters remains the country’s ability to control the spread of the virus and continue to drive down the number of new cases. The same effects apply to equity markets, with the primary driver of stock returns contingent on the number of new cases and the direction of interest rates – which have been reacting strongly to changes in growth expectations.

As cases rise, for example, interest rates decline and growth stocks lead equity markets. But when cases decline and the prospects of a potential resurgence of economic activity drives rates up – value stocks outperform.

Meanwhile, vaccinations are making their way to those willing to get it and at the current distribution rate, we could potentially have 100% of the population inoculated by September. Unfortunately, the J&J vaccine has now been paused, slowing down the pace of inoculations and extending the time it will take to reach herd immunity.

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Once we reach a considerable percentage of the population, the focus then turns to the Fed and inflation and how long the Fed will maintain it’s low-rate stance amid rising prices. It could be a while before inflation starts to impact economic growth or it could happen quickly – opinions vary widely.

Inflation Risk: High or Low?

The latest CPI number suggests inflation is already in the system, with a 2.6% rise in the index on a year over year basis. That is almost a full percentage point higher than last month’s reading and follows a similarly higher than consensus PPI reading earlier in the week. Keep in mind however that both of the recent readings compare to a low base level from last year. The month over month increase, on the other hand, did not have a low base and it did come in a bit hot. With the Fed’s stance to allow inflation to exceed it’s long-term target for a considerable time, it could be concerning if they are already behind the curve.

The counter-argument is that there is still considerable slack in the labor market with many potential workers still not being included in the labor force. The low level of labor force participation means there is still a long way to go to reach full employment and Argus Research suggests the unemployment rate needs to be near 4% before the Fed starts to raise rates again. Will that be too late?