There has been plenty of media commentry in
recent weeks on the potential re-emergence of Inflation on both sides of the Atlantic.
This marks a change in the headlines and also in market sentiment as developed economies
struggle to escape from a low inflation environment despite significant central bank stimulus.
In the UK, we are currently importing inflation as a result of sterling’s decline relative
to our trading partners and a rebound in the price of oil. UK inflation linked bonds have
moved to price in inflation above 3%, which makes them look relatively unattractive to
us now. Despite a recent up-tick the most recent figures
from the Office for National Statistics reported inflation dropped to 0.9% in October, undershooting
consensus forecasts and the Bank of England target. Looking at inflation data going back
to 1750 sub-1% inflation is by no means historically unusual.
Across the pond, US markets are also now anticipating inflation will head higher after Donald Trump’s
election victory. There is clearly the potential for “good” inflation arising from greater
fiscal stimulus – Trump’s tax cuts and public spending programmes – while rental
inflation, and rising healthcare costs, may also give support.
There is also speculation that it could head even higher if Trump follows through on campaign
rhetoric to raise tariffs on Mexican and Chinese imports.
Inflation was already on the way up as economic growth has caused a tightening in the labour
market generating up-ward wage pressure. US inflation linked bonds moved to price in inflation
of around 1.9% after his win which looks fair to us.
We have been reviewing our inflation estimates. Both the Fed and the Bank of England target
2% inflation, and our estimates have been anchored around central bank targets as given
our long-term time horizon it is difficult to diverge significantly from central bank
targets. However, we are assuming inflation modestly above these targets for the UK and
US as policies are accommodative. These assumptions are important as they underpin
our fair-values and our valuation implied returns for equities and bonds. As always
we will look to move our portfolio towards asset classes with the most attractive implied