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.
Inflation data boiling in oil?
Oil prices have moved sharply higher of late, on the back of tight supply and extended cuts by some of the key oil producers. Oil feeds into headline inflation, which central banks officially target, and the degree to which central banks are hawkish or dovish remains a key driver of asset markets. Additionally, even though the oil price doesn’t impact core inflation directly, there are risks of second order effects, where higher energy costs feed through to other components of the consumer basket. The chart below shows the upward pressure oil is applying to headline inflation in the US.
The oil price driving US headline CPI
Source: Bloomberg and U.S. Bureau of Labor Statistics data from 01.05.2020 to 13.09.2023.
Who would be a central banker?
In terms of year-on-year percentage change pressures, to be fair, the oil price is now around where it was about a year ago, but in recent months inflation has actually been benefiting from lower year-on-year comparisons, and this is now starting to fall out. Furthermore, while the move higher in oil might be a temporary spike, let’s not forget that inflation is already above central bank targets in many economies.
This therefore complicates the job of central banks and so feeds into uncertainty for markets. In the Eurozone, headline, and core inflation both remain elevated, while the economic growth outlook is weakening, so stagflationary pressures are building. In the US, inflation has fallen further and growth is stronger so stagflation is less of an issue but, unlike the ECB which just targets inflation, the Fed has dual mandates of price stability and maximum employment. This challenges the dominant narrative that inflation is heading back to central bank targets and detracts from the potential of a subsequent dovish pivot. All in all, this supports our higher for longer base case.
Looking at this scenario it might mean for the third calendar year in a row that US Treasuries loose money. At the same time, yield curve control in Japan is looking increasingly likely that it will come to an end this year, or early next, assuming prices and wages continue to rise sustainably. In short, bonds remain under pressure.
Diversify and conquer
We remain relatively short duration in bonds, emphasising their income characteristics, rather than their diversifying properties. Instead, we look to a material gold position and a smaller agricultural commodities position as non-equity diversifiers of portfolio risk.
Furthermore, within equities, we look to achieve more diversification than normal. For example, we have a significant exposure to Japan and a smaller position to India, which act to diversify global equity risk, also a material exposure to medium sized companies, in part to diversify large tech that dominates equity markets.
