The market appears to have accepted the Federal Reserve’s narrative that rising inflation will be temporary, but Man Group’s Peter van Dooijeweert is less sure. 

“We, as a firm, are a bit suspicious as to whether that narrative is going to hold,” van Dooijeweert, a managing director at Man Solutions who assists clients with multi-asset portfolios, told MarketWatch. “I don’t share the market’s confidence that this is as transitory as it appears.”

The yield on the 10-year Treasury note

has remained low after inflation, as measured by the consumer price index, clocked in hotter than expected earlier this week. Used cars were a big contributor to the jump in inflation, reflecting higher costs stemming from supply problems with chips during the economic reopening from the pandemic, van Dooijeweert said. 

“I don’t think anyone expects used cars to stay extremely hot,” he said, but he worries the housing-related piece of the CPI index will later show up as “a perpetual problem.”

Meanwhile, the biggest tail risks he sees in markets are tied to inflation and rates, at a time when the U.S. stock market is trading around record levels.

See: U.S. stocks close mixed after Powell reiterates expectations for inflation pressures to fade

Fed officials signaled last month in their median forecast that the central bank could hike interest rates twice in 2023. Many investors anticipate that the central bank could begin tapering its asset purchases by early next year, a step that would make it less dovish.

If the Fed has to “catch up” and become more aggressive, faster, in taming a jump in the cost of living, that could spell trouble for the market, according to van Dooijeweert. The U.S. stock market is pricing in “blockbuster” economic growth and company earnings, he said, while high valuations are increasingly worrying clients.

Earlier this year, investors would often ask about where they might earn more yield in the market than from bonds, said van Dooijeweert. Now, they’re more focused on using options to hedge equity risk in their portfolios, he said.

Major U.S. stock benchmarks have posted double-digit gains during the first half of 2021. The S&P 500 index

is up about 16% this year, according to FactSet data.

“We need to be more cognizant of the downside risk probably than we’ve been in quite some time,” van Dooijeweert said. “The scariness of it all is the market can turn really quickly when they start seeing the Fed has to get aggressive and faster.”

Another tail risk is that inflation could erode company earnings more than expected, according to van Dooijeweert. People could become “so excited about top-line revenue growth,” that they miss some of the “expense-line growth” in the inflationary environment, he said. Companies that “can’t control input costs are likely to suffer and struggle in the back half of the year.”

Read: Get ready for peak earnings growth as second-quarter results kick off this week

Meanwhile, the Federal Reserve has had “some pretty big success” in communicating a potential tapering of asset purchases it’s been making under its quantitative easing program, according van Dooijeweert. “The Fed managed to get the taper conversation into the market without killing the bond market,” he said. 

The yield on the 10-year Treasury note fell Thursday almost 6 basis points, to about 1.297%. Yields and bond prices move in opposite directions.

Read: Inflation is going to ease. Just be patient, Chicago Fed’s Evans says

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