JPMorgan addresses the risk of a second inflation wave

JPMorgan Chase & Co. (NYSE:)’s chief market strategist published a new note to clients on Wednesday, highlighting the potential risks of a second inflation wave that could jeopardize the current optimism in the capital markets.

Many investors currently view the market environment as favorably low-risk, the strategists commented, advocating for investment strategies that align with ongoing market momentum.

This period is often characterized by the term “parabolic stock markets” and labeled “platinum-locks,” signifying an even more favorable scenario than the traditionally optimistic “goldilocks” condition.

However, there are peculiar aspects that make current market developments look “odd,” they said.

More concretely, countries like the UK, Japan, and Germany find themselves in a technical recession, despite their stock markets, along with Europe and Japan’s, soaring to unprecedented heights. Further, the market has quickly incorporated high expectations for the impact of various advanced AI technologies on stocks, anticipating a significant short-term economic boost.

But recent economic indicators, including a rise in the Consumer Price Index (CPI) and Producer Price Index (PPI) alongside some weaker-than-expected economic data from the US and other countries, introduce a level of skepticism towards the most optimistic market outlooks.

“With the rallying ~70% in a year, tight labor markets, and high immigration and government fiscal spending, it wouldn’t be a surprise that inflation may stop declining or move higher,” the strategists say.

This, in turn, could challenge the Federal Reserve’s efforts to control it, the strategists warned.

Historically, loose monetary conditions have been a key factor in driving higher CPI inflation. These inflation dynamics exist apart from geopolitical factors like the current low oil prices (which could potentially surge), Middle East shipping interruptions, and the threat of supply chain disruptions in East Asia due to geopolitical tensions or the aftermath of the US elections.

“We believe Investors should be open-minded that there is a scenario in which rates need to stay higher for longer, and the Fed may need to tighten financial conditions,” the strategists and their team said.

“The ~25% stock market rally since October was predicated on a repricing of the Fed (from cutting only 2 times in 2024, to cutting ~7 times in January). While most of those incremental cuts are now priced out, the stock market did not correct at all,” they added.

Moreover, market volatility has remained unusually subdued, while risk positioning has grown significantly over the past year.

With persistent geopolitical tensions in Eastern Europe, the Middle East, and the South China Sea, there’s growing concern over a potential second wave of inflation. These conflicts have already triggered an energy crisis and shipping disruptions in the Red Sea.

The most significant threat, however, stems from escalating tensions or a potential trade war with China, which “could have a much bigger impact on the global economy and would lead to a significant second wave of inflation and market selloff,” the strategists wrote.