David Jane
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Alice was urged to believe three impossible things before breakfast. Markets currently believe at least three, which can’t happen simultaneously.
There has been an inconsistency in market expectations for some time. On the one hand markets have been expecting a material fall in inflation over the course of the current year and into the future, on the other hand they have been expecting this to take place against a favourable economic and company profits backdrop.
It should be clear that inflation can only come down to the levels expected by the market through a material contraction in economic activity. If demand is still strong, labour markets tight and government expenditure continues to expand the price level will continue to rise. Companies and individuals will be in a position to raise prices and wages.
The job, at least as conceived by policy makers, of the central bank has been to ensure a stable price level and therefore, in the current circumstances to bring inflation back under control. Hence the aggressive tightening over the past year. There is however a conflict. The central banks also have financial stability as part of their mandate.
Turning the monetary policy screw
In economies as financialised as those in the West, with huge debt burdens that have built up over the last 20 years, even a small amount of tightening of financial conditions can lead to things breaking. Arguably this is a necessary part of the process of disinflation but one that tends to be negatively perceived. In practice central banks have blinked on every recent occasion that the deleveraging and creative destruction process has begun and reflated aggressively. Markets are expecting them to do the same.
It is that process of ultra-easy money and financialisaton that arguably is the cause of very weak growth in the western economies since the Global Financial Crisis (GFC). Weak businesses have been allowed to struggle on and loss making start-ups have been flooded with cheap financing. As a consequence, truly value creating enterprises have been less able to compete. Productivity growth has been poor as a consequence.
The unanswerable question now is whether the Fed has already tightened enough to bring inflation down short term, in which case how significant an economic contraction and financial crisis are we in the middle of? The market appears to believe inflation is set to fall to very low levels, but simultaneously it doesn’t appear to be pricing much of a contraction and all fear of a financial crisis has dissipated.
Hence, we are at a tricky point in time. We still hold to our higher for longer thesis for the long term but clearly conditions in the near term suggest a bumpy ride for cyclical inflation beneficiaries and equities in general. History suggests that once the Fed starts to ease, equities have a difficult time, as it tends to ease once the harm is done. We stay cautious and have built some further defensiveness into portfolios recently.
