An effective vaccine rollout in the US has paved the way for what looks set to be a spectacular economic party in the second half of the year. Americans are emerging from a tough winter eager to make up for lost time and thanks to a cocktail of household savings and generous fiscal stimulus, this party could go on late into the night. The big question for the second half of the year, is to what extent this appears in real economic growth, or whether it leaves policymakers with a persistent inflation headache. The answer to which will have a large bearing on what happens in bond and equity markets.

While the aggregate numbers hide the hardship felt by many, the amount of excess savings that the US consumer has accumulated is vast. With households forced to stay at home last year, their options to spend were limited and so spending cratered. At the same time incomes were being supported by generous unemployment benefits and “stimmy” cheques that has meant the amount saved soared well above normal levels. Indeed a family of five with total income of under $150,000 (£105,851) received cheques amounting to $7,000 (£4,939). The results are staggering – the US consumer has put away more since the pandemic began than in the whole three years prior.

GameStop gets Gen Z to want financial advice

Such an unusual setup of restricted spending from lockdowns and fiscal support has led to wide disagreement among economists as to the growth and inflation implications going forward. The near-term pickup in growth and inflation is a given, but forecasts show that towards the end of the year, there is a wide dispersion in predictions. So, what mix of real growth and inflation will the recovery generate?

Much will hinge on the extent to which accumulated savings empower consumers to get out and spend. Some caution that savings are concentrated in higher income groups that historically have a lower marginal propensity to spend. But perhaps traditional economic theory falls short here given that consumers have been forced to save, rather than choosing to save. All the indications from the recent retail sales and jobs reports suggest that demand is extraordinary and growth in the industries that were hardest hit are now leading the way.

While it looks clear that demand is strong, the effect on the supply side of the economy is more uncertain. There are significant disruptions in manufacturing supply chains, including a shortage of semiconductors, rising freight costs and higher commodity prices. How transient these bottlenecks are remains to be seen, but it seems complacent to dismiss the possibility that they persist.

There are also price pressures in the services sector and businesses are struggling to rehire workers. The $300 per week in enhanced unemployment insurance, on top of an average regular payout of $320 per week, means that at least half of those currently receiving benefits are financially better off out of work. The enhanced support expires in September, leaving businesses with a dilemma. Do they pay more to hire now in order to meet the surging demand of the recovery, or wait until the benefits expire and hope to re-hire employees then at a lower cost? We suspect that given the strength of demand, many businesses will be forced to pay up.

Liontrust makes ESG pitch with new investment trust

The US Federal Reserve (Fed) has indicated that it would welcome a near-term inflation overshoot. Pre-emptive policy tightening to head off building inflationary pressures looks a thing of the past – the Fed has committed to only raising rates once full employment had been reached and inflation is at target and on course to moderately overshoot. This explains why the Fed intends to look through the current inflation pickup as transitory and is still carrying out $120bn in quantitative easing each month, in a year when the economy could grow at its fastest rate since the 1980s.

This raises the possibility that together, the Fed and Washington have made the policy punch a little too strong and could leave themselves with an inflation headache. Should the incoming data start to raise question marks around the Fed’s hypothesis that inflation is transitory, then volatility in Treasury markets could rise as investors try to reprice the implications for the Fed eventually having to tighten more aggressively to regain control.

How should investors prepare for the party? With the inflationary risks seemingly skewed to the upside, we think it makes sense for investors to be relatively light on duration in portfolios. The prospect of higher Treasury yields should support cyclical and value stocks, as these styles tend to outperform in this environment. Conversely, areas of the market that have been buoyed by low Treasury yields could struggle. For those that can stomach the liquidity constraints, diversifying portfolios with real assets that have low correlations with both bonds and equities and can provide some inflation protection could make sense – infrastructure assets stand out as one example in this respect.

For now the music keeps on playing, but investors need to be aware of the risks that a persistent return of inflation could dramatically change the mood of the party.

Ambrose Crofton is global market strategist at J.P. Morgan Asset Management