I’ll get to inflation in a second. Last week was one of those classic weeks where contradictory factors were cited as being factors hurting risky assets, suggesting that neither was really that much of a factor. Supposed worries about global economic growth were blamed (how many times have we heard this before). Yes, U.S. first-quarter growth forecasts have been cut as consumer spending has not come out as strongly as expected. But some economists, such as Lou Crandall at Wrightson ICAP, are expecting this to be a mathematical head-fake (blame national income accounting) that belies the strength seen across indicators. China’s trade figures for March, the first not to be impacted by the Lunar New Year, showed robust growth both domestically and abroad, as reaffirmed by the roaring GDP figures for Q1.

Suddenly this morphed into an inflation worry story for China on Thursday and Friday, even as the Shanghai Composite showed little reaction — both to the supposed inflation fears and the actual Sunday hike in bank reserve requirements. Food prices remain a sensitive issue in China, as well as the country-specific issues confronting India. But in China and elsewhere, a bevy of measures have been taken to ease the pain. The commodities story is one that gets simplified but is complex: several individual markets have faced supply shocks. After the shock, many prices — especially softs and grains — have leveled out and are off this year’s peaks.

For that reason inflation is expected to start slowing in the second half of the year unless commodities keep running higher. Oil prices remain high but are probably driven more by the strong growth in Asia and emerging markets, hence the positive correlation between oil and equities holding up. There are reasons to be worried that inflation could get out of hand and prompt a harsher monetary response. But we are not there yet. The IMF’s warnings about Asian economies overheating state the obvious. At the same time, many commentators seem to forget that most the extra funds from the Fed’s QE2 end up stashed back at the central bank itself in the form of excess reserves, not running wild in asset markets.

China is well into its tightening campaign across all channels: limiting bank lending and mopping up funds in the banking system via record high reserve requirements – on top of lifting policy rates. All Asian central banks have started to tighten, even in those countries where inflation is within policy targets. Importantly, stronger currencies are clearly part of the tightening mix, and in Indonesia a well-declared one.

Asian equities have bounced back quickly from the selloff at the start of the year that was supposedly driven by inflation fears. If inflation were a real worry, we would see a similar response. We are not. Why? Because central banks are tightening, some prodded by investors yanking out funds on those initial inflation jitters. Bond markets are expecting higher rates across the region and if anything are still not quite full factoring in the rate hikes that may be delivered, as Deutsche Bank argues. Stronger currencies and flatter IRS curves remain the dominant theme.

Equities can still push higher in this environment. We’re not talking big double-digit gains, but unless margins are really squeezed equities can keep climbing as long as central banks are not too far behind the curve. As HSBC’s equity strategists put it, the inflation risk is one that is now well-known and “unlikely to surprise further on the upside.” Again, the relatively conservative pricing in AXJ equities makes this possible: on I/B/E/S data, the 12-month forward price-to-earnings ratio on the MSCI Asia-Pacific ex-Japan is at 12.2 versus a long-term average of 12.8. Even if margins are squeezed a bit more than expected, HSBC says there is 13 percent upside this year in AXJ shares.

“Margins may be under a little more pressure than analysts now appreciate because of rising commodity prices, but double-digit earnings growth seems achievable.”

Economist Jonathan Anderson at UBS was also very explicit: “Barring a significant further upward spike in oil and commodity prices it seems far too early in the cycle for us to be unduly concerned about EM-wide margins. In fact, our strategy team is still looking for an overall margin expansion in 2011.”

EM markets, and Asia in particular, are outperforming at the moment. Foreign investor inflows have picked up. That’s a relative growth story at a time of strong global growth, with inflation one outcome but not necessarily a problematic one yet.

PIMCO may be no fan of U.S. Treasuries and seems to have front run S&P’s threat to downgrade the United States’ long-held AAA rating. But the big bond fund expressed confidence in a client note that Asian policymakers will respond appropriately, recommending exposure to Asian sovereign credits and currencies.

“Importantly, the focus is on preserving price stability as a necessary condition for sustaining economic growth over the long term. To this end, we expect central banks to broaden policy tightening to include other monetary instruments, including the exchange rate.”

Mild equity gains, stronger currencies and flatter curves: they are not mutually exclusive.