Wrong for investors to dismiss inflation threat

EARLIER this year, the big fear was that inflation was going to surge, led by the

US, and that this was going to drive aggressive interest rate hikes by the US Federal Reserve and much higher bond yields, which in turn would pressure other asset classes. Such fears sparked a significant correction in global share markets with US shares falling 10 per cent, global shares falling 9 per cent and Australian shares falling 6 per cent. Since then, inflation fears seem to have taken a back seat. While in most major countries 10-year bond yields are well up from their 2016 multi-decade lows, US bond yields have struggled to stay above 3 per cent, German bond yields are around 0.3 per cent, Japanese bond yields are around 0.09 per cent and Australian bond yields are around 2.58 per cent, with most well below their highs seen earlier this year. So, what happened? Should we still worry about inflation?

What happened?

A whole bunch of things have helped bond yields remain low and kept investors focused elsewhere:

Implications - another extension to the cycle?

These considerations have combined to help fade the inflation/Fed tightening fears of earlier this year with the result that bond yields have been contained and most share markets have been able to recover from their February inflation-scare lows. In some ways, it is more of the same because the whole post global financial crisis experience has been one of two or three steps forward towards stronger global growth followed by one or two steps back (with eg the eurozone debt crisis, the 2015 growth scare and various deflation fears along the way). What we have seen this year is effectively a continuation of that.

Delaying or slowing monetary tighteninghas helped to extend the economic and investment cycle. The implications have been:

With global monetary conditions remaining easy and US recession warning indicators still not flashing red (although the yield curve is worth keeping an eye on), our assessment remains that the investment cycle has more upside and that a US recession remains a way off yet. However, the main risks around this relate to the threat of a global trade war should the tariff threat from the US continue to escalate.

Should we still worry about inflation?

It would be wrong for investors to dismiss the inflation threat - particularly in relation to the US:

US President Donald Trump's tweets critical of the Fed raising interest rates are of concern in this regard.