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Strategist on inflation: It’s ‘going to surprise in Q2’

Clocktower Group Chief Strategist Marko Papic joins Yahoo Finance Live to discuss the latest market action.

Video Transcript

AKIKO FUJITA: Let's turn our attention back to the markets right now with Marco Papic. She is Clocktower Group Chief strategist. And Marko, let's stick with the earnings theme here because we've been sort of dissecting a number of these companies reporting. Sort of a thread that we're seeing, more and more companies guiding now, talking about sort of this optimism coming along with the acceleration of the vaccine distribution. What kind of narratives have you been watching in the companies that have reported so far?

MARKO PAPIC: Well, I think the main narrative is that there is both the opening of the economy, but also the fact that there is massive fiscal stimulus that's still coming down the pipeline. Even though from the previous stimulative efforts in 2020, we have about a trillion dollars worth of cash that hasn't been distributed by the government. So if you think about that, there's $3 trillion, potentially, that's going to come down the pipeline.

And I think that's what's really important, and that I think the market is not really considering, is the fact that this stimulative package will pass through reconciliation procedure, which in the past has been used for profligate stimulative efforts but mostly tax cuts. So this is really the first time that the government is going to use the reconciliation procedure to pass through a stimulative effort that's mainly just spending.

And I think that once policymakers get a taste of this, there'll be more coming down the pipeline, which will almost ensure that we close the output gap and that growth surprises to the upside. So I wouldn't be surprised if we see nominal growth in double digits in 2021.

ZACK GUZMAN: On the monetary side though, there's still a lot of concerns out there on the inflation front and what could happen there. We've seen commodities catch quite the rally, the dollar weakening here. You say oil prices could surge to $80 a barrel by the end of the year. Talk to me about what you're seeing on that front and what investors should keep in mind when it comes to inflation.

MARKO PAPIC: I think the most important thing is how is the Fed going to react to what's clearly going to be an inflationary spike in Q2, I mean, clearly. It's a rate of change thing. It's a mathematical certainty that we get it because of what happened last year.

And they already have an excuse. We already know they're going to claim it's transitory. I think that the sequence that we should be thinking about from a macro perspective is this. Inflation is going to surprise in Q2. The Fed is going to say it's transitory. Inflation expectations however, which are measured by economic agents responding to higher inflation, are going to respond because I don't think the CEOs or households think that it's going to be transitory.

And then in Q3, I think we're going to have some indigestion in the market, as the Fed has to start signaling at least a modest turn away from extreme dovishness. Now, I don't think they're going to get hawkish. I'm not saying they're going to start talking about raising rates. I'm just saying in Q3, there should be some indigestion. But then Q4 and then Q1 of next year, the market's going to reset higher.

We're in a bull market--

AKIKO FUJITA: Marko, when you talk about a surprise coming, we're looking at core inflation at 1.4% right now. How significant do you see that spiking?

MARKO PAPIC: I think core inflation, by Q3, could be between 2% to 3% easily and then in terms of headline, 5% to 6% even. So you know, look, the Fed's going to have to respond to that. And that's going to cause some indigestion at some point, probably Q3. But I would still think that eventually-- how are they going to resolve any market turbulence? They'll err on the side of dovishness, at least until 2023.

And that means we're in a bull market. But for investors, what it means is that it might be a shorter cycle than the last one. So waiting for corrections or waiting for momentum and technicals to get healthier, I think, will mean missing out on chunks of performance.

ZACK GUZMAN: Yeah, I mean, obviously, it's an interesting time when it comes to inflation expectations. And obviously going to be a tough spot that the Fed might find themselves in later on this year as well. But Marko Papic, Clocktower Group Chief strategist, appreciate you coming on here to chat. Be well.