In the latest Perspectives, Anthony Rayner, fund manager of the Premier Miton Macro Thematic Fund range, argues the market thinks inflation is dead again. But is the market getting ahead of itself?
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 most Western economies the inflation picture is much improved. This is the case not just at a headline consumer price level but also at a core inflation level. Even services inflation has fallen, though it still remains somewhat elevated and, importantly, is a metric closely followed by central banks.
A general fall in US inflation and weakening in the labour market, has led to headlines heralding the death of inflation and a subsequent more dovish outlook for Fed rates.
The chart below illustrates the amount of cuts priced in by the market by year end, currently 100bps, and specifically how the dovish outlook grew in July and August, and how this has contributed to a weaker US dollar.
A more dovish outlook of late has led to a weaker US dollar
Source: Bloomberg 29.06.2023 – 28.08.2024. Past performance is not a guide to future returns.
The big drop at the beginning of August this year reflected the market turmoil and the perception that it meant more cuts were likely. Subsequent data, and dovish commentary from Fed speakers, has stopped expectations of rate cuts returning to pre-turmoil levels.
Further out, the market is assuming about eight cuts between now and the end of July 2025. This strikes us as excessive, as the market is also assuming no US recession. Indeed, let’s not forget that looking back over this cycle, the market has consistently got ahead of itself –in fact seven times, according to Deutsche Bank research. The Fed, however, will remain data dependent.
So, what impact will this have on financial markets?
As illustrated above, the increasingly dovish outlook for Fed rates is seeing weakness in the US dollar versus the major currencies, and as markets digest changing interest rate differentials, so currency volatility remains elevated.
US Treasuries have rallied hard on the more dovish outlook, but perhaps have gone too far too fast, and equities have benefited too from the more stimulatory environment.
We have had a higher for longer base case for over two years now but have been adjusting that over the short term, in line with a pragmatic response to the better inflationary environment. For example, we have been adding to bond duration, adding to equities and reducing US dollar exposure.
However, further out we don’t think inflation will fall to around 2% and obediently stay there. We believe that inflation will reaccelerate and remain above central bank target rates. This structural view of higher for longer inflation is driven by the powerful and interrelated forces of deglobalisation, increased global conflict and a lack of fiscal discipline.
This is a stark contrast to the disinflationary period previously, which was dominated by globalisation, relative global peace, and much more fiscal discipline.
Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
