February 23, 2022

Long-Term Inflation Expectations Critical For Equity Strategy

The Fed is obsessed with surging actual inflation, but the chart shows that the long-term inflation breakeven rate is more important for intra-equity trends such as global cyclicals/global defensives and small caps/large caps. This rate still has a center of gravity around 2%. The best-case scenario for equities is “more of the same”. An upside breakout would deepen Fed worries that they have “let the inflation genie out of the bottle” and increase the odds of an equity meltdown. A more significant risk off the radar screen of equity investors is that long-term inflation expectations fall below 1.5% as the Fed tightens and the economy slows. That would make for a difficult corporate pricing power environment and undermine global cyclicals, small caps, highly-leveraged companies and momentum stocks.