The lack of inflation is the key theme in the investment landscape at the moment. With global growth moving to a lower path post the global financial crisis, one wonders where inflation is going to come from outside of a supply shock from some adverse geopolitical or weather related event.
In the US, inflation is still running below the target of 2% despite six years of zero interest rates and US$3.5 trillion of asset purchases. Inflation in Europe is even more restrained, consistently below 1%, which is forcing the ECB to become more unrestrained. Inflation in China is only 2% while property prices are actually deflating around 1% a month at the moment.
The recent slump in global commodity prices is expected to dampen inflation further in the near term. One would think inflation will eventually come from the US labour market, but even here competition from globalization and technology could keep wage growth in check even when labour market slack is used up. In New Zealand’s case, relatively open borders means globalisation takes the form of higher net migration, adding to labour supply. Some regions such as Europe and Japan are looking to spur inflation through currency depreciation, but this just exports disinflation to the rest of the world.
It is way too early to write inflation’s obituary but it seems the low inflation backdrop and its consequences of low global rates and rising asset prices will be around for some time yet. This expectation raises the risk of excess leverage, asset price bubbles and the eventual messy unwind. Equity market valuations are not irrationally exuberant but other indicators such as bank lending, broker margin debt and high yield credit spreads bear close monitoring.
Low global rates do not mean zero rates and the US Fed and the Bank of England are on course to lift rates from the floor next year, which could cause some instability in markets, even if the ECB and BoJ are on hold as far as the eye can see.
In view of the low inflation backdrop, we think rising interest rates in the US and UK will be accompanied by higher growth, which ultimately will be positive for shares given valuations are not overextended. We expect rising US rates to modestly pull up US and global long term yields, lift the US dollar higher, and by implication push the New Zealand dollar lower.
Consequently we remain underweight for the New Zealand dollar, at benchmark for equities, underweight for bonds, overweight for cash across our diversified portfolios and an overall neutral growth position.
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.
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