Everybody Expects Inflation to Soar This Year

When nearly everyone in the financial markets expects something to happen, usually something else happens. This creates opportunities for the few people who dare to use contrarian strategies during times of consensus.

At the beginning of 2023, everybody and his uncle thought the stock market would go down that year. As it turned out, stocks rallied sharply in 2023 and again in 2024.

That’s just one example. I could also point to March of 2020, when people assumed that the market would continue to decline and hardly anybody wanted to buy stocks. In actuality, that was the best time to buy stocks.

The market is highly efficient and forward-looking, so when the vast majority of people expect something to happen, this assumption gets priced into stocks immediately. Then, if that event doesn’t happen to the extent that people assumed it would, there’s typically a snap-back effect with stock prices.

Currently, practically everyone expects inflation to move sharply higher during the Trump administration. The betting markets tell the tale, with calls for higher inflation ramping up immediately after Trump’s re-election:

Courtesy: @kalshi

I just a couple of months, the prediction markets’ inflation-rate expectation has jumped from around 2% to more than 4%. This belief, along with the market’s concern that interest-rate cuts won’t happen as frequently as previously assumed, explains why stocks have been so volatile lately.

It’s not only retail traders and the prediction markets expecting inflation to soar. Federal Reserve officials are also practically unanimous in their expectation of higher inflation.

This is evident in the minutes of December’s FOMC meeting. “Almost all participants judged that upside risks to the inflation outlook had increased,” the minutes stated.

The word “participants” means Federal Reserve officials, of course. And, without actually mentioning Donald Trump, the Fed officials are already blaming the President-elect for an assumed inflation surge that hasn’t actually happened yet.

The minutes from the FOMC meeting clarified, “As reasons for this judgment, participants cited recent stronger-than-expected readings on inflation and the likely effects of potential changes in trade and immigration policy.” Again, there’s no doubt that the Fed officials are talking about Donald Trump here.

In case anyone didn’t get the memo, the inflation rate has already bottomed and started to move back up. Also, inflation never did reach the Federal Reserve’s 2% target.

Interestingly, the S&P 500 has been choppy and hasn’t been able to sustain a rally since the December FOMC meeting. Clearly, stock traders are concerned about the economy in the near term.

Courtesy: ZeroHedge

During that same time frame, bond yields have surged while both gold and the dollar have strengthened. These all indicate that the market is nervous about near-term events and is seeking safe havens.

For contrarian investors, this is a time to ask, “What if?” Specifically, what if the consensus assumption is wrong and inflation doesn’t soar while Trump is in office?

The consensus assumption of sharply higher inflation is deeply ingrained at this point. Consequently, if inflation rises but only moderately, there could be a snap-back effect with a relief rally in risk-on assets.

This is a perfect example of why investors should be aware of consensus forecasts but should form their own conclusions based on the available data. Consider the times when the market assumed the worst-case scenario, but then risk-on assets rose when the world didn’t actually collapse.

Granted, contrarian investing is easier said than done. It requires due diligence and emotional fortitude – but if applied correctly, going against the grain can yield amazing results.