In Europe, equity markets worry that there is no growth – fear of inflation has disappeared. In the US, equity investors are uncertain whether the problem ahead is slowing growth or rising inflation. I reckon growth won't be a problem in the US this year. But, ironically, that will be a big problem for investors since it will deflate asset and debt bubbles as interest rates move much higher than expected.
Why will rapid growth be bad news for investors? First, higher inflation in the US will raise the nominal and real cost of capital, making the cost of servicing debt mountains unbearable. Second, that will promote a further precipitous fall in the dollar that would have much the same effect. Third, rising debt costs could cause an exogenous shock to the financial system, such as a major bankruptcy.
Dog dollar
Higher inflation would have several impacts on financial markets. It would suppress risk appetite and increase volatility. US and European financial asset performance would decouple (as inflation became a mainly US trend). Equities would suffer from rising capital costs, disappointing profits and reduced risk appetite. Bonds would be hit by higher inflation and, in many categories, reduced risk appetite.