Inflation assumptions are a gamble for portfolio managers at present and Suncorp is looking to the United States Government to set the odds.
Citing some signs coming out of the US, Suncorp executive manager of investment strategy and portfolio management, Gwion Moore, is maintaining a cautionary view on inflation, primarily because he is not convinced President Trump will succeed with his infrastructure plans.
“Great expectations were built up about what Trump was going to do fiscally and the market has priced those in, but the real economy has not moved in that direction yet,” Moore, says. “There is a large gap between market expectations and what is occurring.”
The softening of US economic data in the last few weeks is evidence of this, he explains. Business investment has dried up as investors wait for infrastructure plans to come online. If these plans fail to materialise, the market will be pulled back to reality.
“I have a modest bias towards disinflation. That being said, there is a bit of a cyclical pick up, with unemployment falling quite steadily. But because debt levels are so high in the US, one or two interest rate rises from the Federal Reserve can cap any inflation growth,” Moore says.
AI versus the social democrats
The real piece of the puzzle for long-term inflation is employment. Moore has his sights set on two intriguing developments that could have a large impact on wage growth: artificial intelligence and its consumption of available jobs, and the recent rise of a political movement that prioritises labour over capital.
“Artifical intelligence is likely to weaken economic demand further but a shift could come in the form of a social democractic political movement,” he explains. “In many ways, Bernie Sanders was more of a surprise than Trump, and Corbyn’s success in the UK was an enormous surprise. A social-democratic world would push inflation higher because of greater support for labour and social spending over capital. The movement has the potential to change things but it’s likely to be a slow-moving process.”
Faced with these two opposing effects on employment, Moore is taking the middle road and betting on low growth and inflation. In the short to medium term, he does not see interest rates rising much and expects yields on US 10-year bonds to remain in the 1.8 per cent to 3.0 per cent range.
“I’d be cautious about taking an out-right short-duration position unless interest rates are near the bottom of the range, as there is a lot of pressure to buy in at the right price,” Moore explains. “I prefer short-duration credit spreads, which currently offer the most attractive risk-adjusted return.”
Gwion Moore will be part of a panel discussion titled “Betting on Reflation or Deflation: Managing the risk”, at the Investment Magazine Fixed Income, Cash, and Currency Forum, to be held in Healesville, Victoria, on July 25-26, 2017. To view the agenda or to register, visit the event website.