Inflation on the radar

Debt markets grabbed the headlines, where sovereign bonds had their worst month for a number of years. The ten year gilt yield almost doubled over October, while US treasury and bund yields each increased by 30 basis points, returning bunds backs into positive yield territory. The potential for a step-up in inflation is getting increasing coverage from economists and, where this year began with China and commodity worries, it may now close with the focus on rising inflation.

There is a compelling case for UK consumer price increases over coming quarters. At current sterling levels, importers are coming under pressure and will be looking to push prices higher. Furthermore, the headwind of lower oil and hard commodity prices will soon be coming out of annual inflation comparators. Beyond the UK, recent data has demonstrated inflation rising from a low base; US core inflation increased to 1.7% in September and Eurozone CPI was 0.5% in October – the highest level since 2014.

Central bankers have continued to resist adding further monetary stimulus, as typified in Draghi’s uneventful recent policy announcement. Market expectations of monetary tightening are on the rise, with the Fed predicted to be first to move with a December rate rise. The reaction in bond markets over recent weeks reflect this worry. I tend to agree that a return to higher levels of inflation is likely in 2017 but at the same time, would be surprised to see central bankers rushing to tighten policy - at least in the near-term. Central bankers globally have been fighting to generate inflation for a long time and a swift hawkish move would be uncharacteristic.  I continue to favour equities over bonds as an asset class, on the basis that this should provide a greater degree of inflation protection over coming quarters and that, on a relative basis, equity valuations appear less inflated.

Fred Mahon is the fund manager of JM Finn’s Coleman Street Investments service. Click here for more information