In a market that’s too stressed about inflation, cash is king among the income assets, according to Schroders.
Simon Doyle, head of fixed income and multi-asset at Schroders, said “the market is over-worrying about inflation. The things that make me stay awake at night are: policy responses in the US, the EU, China and Australia; inflation or inflation surprises; China; and Australia.”
Cash is king in inflationary times, followed by gold and commodities, “but timing is critical when thinking of commodities as inflation hedges”, he said, adding that bonds reign supreme in disinflationary periods.
The first big issue for Schroders was US public debt. Treasury-bond yields should be a lot higher than they were: 10-year Treasury bonds had pushed below 3 per cent, Doyle said.
He cited Carmen Reinhart and Ken Rogoff’s research which showed no apparent contemporaneous link between inflation and public debt levels for the advanced countries, and so it should not be surprising that there was no link between debt levels and bond yields.
US government funding needs had risen, while household savings had been offsetting this “in an aggregate sense” and the way this was resolved was “very important”. If the US government started to tighten fiscal policy to rein in deficit before household demand rises, there would be a major problem and this would be the catalyst to tip the US economy back into recession.
“So, it’s policy response by the US government and the Fed which are important,” Doyle said.
Europe was also keeping Doyle awake because of its common currency, but very divergent economic, social and political conditions. Moody’s had given Greece a 50 per cent probability of defaulting, along with Cuba, but the much bigger problem was Italy and Spain – because banks in France, the Netherlands, Germany and the UK had very large exposures to these two countries.
The third big issue was China where inflation was rising, despite the central government’s measures to curb it. This was because 40 per cent of lending was outside the mainstream lenders, so total loan growth was rising.
Australia was already showing symptoms of the Dutch disease, Doyle said. The mining sector was “absolutely rocketing along”, but he pointed to weak retail and housing prices as the big issues which were more important than overstating the problem of inflation.
Inflation was not a larger problem “because it’s been priced in already. Investors are buying inflation hedges: commodities, gold, ETFs, inflation-linked bonds (ILBs)”, he said.