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.
In a week when a number of important US data series were weak, financial markets rallied hard. We’re still in the bad news is good news period, where markets take weaker US economic growth to mean less hawkish US monetary policy.
As both equities and government bonds rallied hard, it seems that markets are also assuming a soft landing for the US, i.e., a slowdown that avoids recession. Playing devil’s advocate, the journey to a soft landing, in the early stages at least, often looks very similar to the journey to a hard landing. If it turns out to be the latter, bad news will end up being bad news again. And, even if the US has looked pretty resilient until recently, most other big economies, for example China and Germany, have looked much less so.
Turning to the weaker inflation environment, most investors we speak to, and indeed the break-even markets (see chart), are assuming inflation will revert back to around 2% and obediently stay there.
Markets are assuming a well-behaved US inflation outlook
Source: Bloomberg, data from 24.10.2022 to 09.11.2023.
Goldilocks all over again
Growth, but not so hot that it stokes inflation. Really? Too good to be true? It’s difficult to say but certainly markets have repeatedly believed that they are on the point of a dovish pivot, only to be proved wrong numerous times in recent months by inflation data and/or a hawkish Fed. If the belief in a dovish pivot is again wrong, and at some point it has to be right, it might not mean that rates move higher but rather plateau, though even that will likely be of some concern to markets.
Our view on inflation is somewhat different to the market’s
Remember that inflation in all the G7 countries remains above target, even if it is falling. We believe that there are a number of structural dynamics that argue that inflation will reaccelerate. Interestingly, many of these are the very same dynamics, though in reverse, that pushed inflation lower over the last 25 years. Globalisation has moved to deglobalisation, resource abundance has moved to resource constraint and fiscal prudence has moved to fiscal profligacy. On top of that, the conflicts remain in the Ukraine and the Middle East, which are important in terms of food and oil prices respectively.
That said, in the short term, markets have become less focused on both conflicts. What seems key for markets in the Middle East is that the conflict doesn’t become regional in nature. This is well illustrated by the lower oil price, which has also been a driver of the risk-on rally.
Talking of which, markets have got what they want short term but they should be careful what they wish for longer term.