As we approach the fourth quarter of 2017, investors’ eyes will not be looking towards to a single geography, or a single event, for guidance. Unlike last year, when the final three months were dominated by Donald Trump’s election victory and subsequent equity market rally, investors appear both relaxed and nervous at the same time.
There is little doubt the global economic cycle is in an okay place. Commodity prices are back up following the 2014 crash. And while 2017 has not been as expansive as many believed in January, progress is still being made.
Yet inflation, while rising, is still weak in some parts and wage inflation remains “illusive”, according to Capital Economics. This is putting a lid on signs of a real concerted economic growth phase: that is, strong core inflation and rising bond yields.
Andrew Kenningham, the firm’s chief global economist, says that despite several countries approaching full employment there is no evidence of wage inflation, which is holding economies back. This trend is prominent in eurozone pack leader Germany, and Japan. The US has even seen a decline, while UK wage growth remains far below its consumer prices index.
Despite commodities demand growing – although price increases are also due to supply-side factors – its impact on global inflation is dwindling.
Mr Kenningham says: “For the coming two years or so, core inflation will probably remain a little below target in the eurozone and a long way below target in Japan. Only in the US do we anticipate that core inflation will rise above the central bank’s target on a sustained basis.”
Capital Economics forecasts global inflation to be 2.4 per cent next year, with GDP growth coming in at 3.3 per cent. The weaker-than-expected inflation outlook feeds into one aspect of portfolio management where many remain nervous.
The fixed income bull market has continued in 2017 despite every expectation at the turn of the year for yields to rise and normality to return somewhat. The yield on a 10-year gilt, currently 1.16 per cent, is lower than at the start of the year while global corporate debt has returned 4 per cent year-to-date.
Central bank stimulus remains, despite plenty of talk about withdrawal. But, according to Mr Kenningham, the Fed is on “the verge” of unwinding quantitative easing (QE).
“Even though inflation is low, policymakers are gradually withdrawing policy stimulus against a reasonably strong economic backdrop,” he says.
This, and subsequent tightening in the eurozone and the UK – which might not be far behind – will affect fixed income markets.
As inflation remains weak, markets seem content with bond valuations, particularly given QE and a floor on bond prices given institutional buying. However, according to Goldman Sachs Asset Management (GSAM) bonds could suffer if inflation moves much higher.
In its latest report, the fund house says it is “bearish on government bonds” and “cautious on credit”.
The report says: “We are cautious on the sector, but we think it is still too early to position for significant widening in spreads.” However, it adds: “We are approaching the point in the cycle where credit spreads have historically [started] to widen.