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Are commodities the canaries in the inflation coalmine? PAM Insight CIO roundtable asks
08/08/2018 , Tristan Blythe, Editorial Director

Are higher commodity prices the canaries in the inflation coalmine and are we about to enter a period of runaway inflation? That was the question that a recent PAM Insight roundtable, in association with Invesco, asked a group of chief investment officers. The discussion took place at the London offices of Deloitte.

Andras Vig, multi-asset strategist at Invesco, said many of the traditional warning signs suggested that inflation was about to increase. If it does then it would be a “long threat” that hits “most financial assets,” he said, although they react differently.

For example, equities and gold are both often cited as hedges against inflation. However, Mr Vig said that equities will de-rate under inflationary circumstances and gold’s “reaction to economic news has been changing in the last ten years” which means it could now react to inflation. On the other hand there tends to be a sell-off in fixed income.

He added that is also important to consider what might cause a period of higher inflation. Mr Vig said, unlike the 1970s and 1980s, positive economic growth is the likely cause of the next period. Low levels of unemployment in most major economies will eventually lead to wage growth which then can trigger higher inflation.

However, this wage growth has not yet happened. Also Mr Vig said that inflation tends to coincide with long term population growth. In the established economies, and even the fast growing emerging markets, this is not the case.

Inflation levels have remained stable for some time and are not showing any sign of picking up. So, Mr Vig asked, “Are we at an inflection point?” Are we about to enter a high inflationary period or not?

Don Smith, chief investment officer at Brown Shipley, said that perhaps there was no need to be as “scared” of inflation as many are. He said that in recent times there have been a few periods when people have expected higher levels of inflation, but it has not occurred. He said that the world is a very different place to the late 1960s and the 1970s. He added: “People have the sense that inflation is the big monster to slay. I suspect that Central Banks really want to control the business cycles. But what caused the last global recession? It was a credit boom. Credit is a difficult thing to measure in a clear way.” In Mr Smith’s opinion the tightening of monetary policy by the Fed was not due to inflation worries but that they are worried about demand for credit and low interest rates causing future problems.

It was discussed as to whether the current ways of measuring inflation were still relevant given how the world has changed. Also it was questioned whether inflation targets, which were set when the economic situation was very different, are still applicable in the modern world.

The attendees of the roundtable all agreed that China was a key element in the future of the global economy generally and the inflation outlook.

There was a consensus that China will play an important role in the type of inflationary environment that emerges. Indeed, Manish Singh, chief investment officer of Crossbridge Capital, said that by producing goods at a cheap price China had, in recent history, had a “massive disinflationary effect on the global economy.”

Firstly, there was the view that China will become a major economic superpower. This will probably be on a scale that has not been seen before.  However, Mr Smith added that China was still on the path to this and “was not there yet.”

However, there were other reasons provided for why Trump may be pursuing a “trade war” policy, despite its inflationary outcome. Sir John Royden, head of research at JM Finn, suggested that the threat of, and introduction of, tariffs had provided the president with “a brake on the economy” that was separate to and independent of the Fed.

Although there was a sell-off in equities in February when inflationary fears surfaced after the publication of the US employment figures, this has “faded into the background,” Mr Vig said. It has instead been replaced by fears over a possible “trade war.”

Michel Perera, chief investment officer of Canaccord Genuity Wealth Management, suggested that President Trump was fixated on “blue collar jobs” and bringing manufacturing jobs that been moved to other countries back to the US. He said that the President was less interested in protecting intellectual properties. He cited data that shows that US manufacturing employment has dropped “since China joined the WTO.” He added that President Trump was “living in the past” and that companies would not repatriate production to the US.

Vassilis Papaioannou, chief investment officer of Dolfin Financial said he “slightly disagreed” with elements of this. To him, all populist politicians focus on blue collar jobs. In his view President Trump’s stance on China was about “trying to balance the trade relationship.” He pointed out that China is undergoing transformation in becoming a consumer-led economy. President Trump wants to ensure that China opens up and consumes mainly US-produced goods and services .

Mr Singh agreed that corporates would not move production back to the US. He said these businesses had realised that the US was in decline on the global economic stage and China presented a big opportunity. He added that the political authorities in the US knew this but had not accepted it in the same way.

China is definitely on the ascent while the US is in decline, the attendees said. This was thought by some to be behind President Trump’s current actions regarding trade with China and the European Union.

“There is nothing Trump would like better than to break up the European Union so that he can make individual trade deals with each nation,” said Mr Singh. He added that this was possible whereas breaking up China’s resolve would not be. He said that America realised that it “had a chance to make a trade deal with China and maintain some of the advantages it still enjoys,” adding they would not have the chance in five years when China has developed even more.

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