David Absolon, investment director at Heartwood Investment Management said bond markets in particular do not believe central banks reassurances on inflation, with the inflation rate implied by bond markets considerably lower than central bank targets of 2%. Equally, some economists argue that lower oil and other commodity prices are exerting significant deflationary pressure worldwide, rather than acting as a boost to the consumer.
In contrast, Absolon said that while deflation risks have increased, a significant downturn continues to remain a small probability and developed economies, particularly the US, should see a return to a more normalised environment, albeit subject to a lower growth and inflation outlook than relative to history.
He added: “Over the short-term, there are two trends that should provide more comfort that developed economies can withstand global disinflationary forces. First, we would need to see evidence of a stable oil price. This may seem an elusive prospect after last week’s price gyrations (Brent crude oil fell 6%), but there are signs that the equilibrium between supply and demand is starting to adjust….
“Second, following its meaningful appreciation since July 2014 (17.5% on a trade-weighted basis), we also need to see a stable US dollar as it retains its preeminent role in global trade and commodities.”
Absolon said that while attention has focused on the deflationary impact of a Chinese slowdown, inflation trends in the US are just as important to the global growth and inflation outlook , given the US economy remains the significant engine of global growth. He points out that US core inflation has remained steady throughout this period and currently stands at 1.9% in September.
In this environment, he said, “The overall focus among policymakers appears to be on initiating a rate rise sooner rather than later. There is a risk the bond markets might be caught off-side.”
Alan Higgins, UK chief investment officer for Coutts agreed that headlines focusing on gloomy central bank decisions and the economic travails of China suggest a global economy in the doldrums but surveys from services companies around the globe show more robust growth. He added: “Services are by far the dominant part of economies in developed markets, and increasingly so in the larger emerging economies. There is an important distinction to be made between poor-looking manufacturing numbers and what we are being told by companies selling services.”
He said: “This supports our ongoing view that markets are reading too much into central bankers’ hesitation over rates and some weak economic data coming out of China. While some areas of the global economy have been hit, the overall outlook remains positive.”
