UK inflation in context: three key charts

The return of inflation has been one of the dominant themes since the start of the year. Economic data in Europe and the US have both surprised on the upside while in the UK fears of deflation, which were so much a part of 2016, now seem a long-distant memory.

This is borne out by the latest figures from the Office for National Statistics whose Consumer Prices Index (CPI) jumped to 2.3% in February, up from 1.8% in January. This breaches the Bank of England’s 2.0% target and the bank itself has said it expects inflation to peak at 2.8% next year.

Two things are at play here: first, sterling’s weakness since the Brexit decision has increased the cost of imports; second, the increase in commodity prices, particularly oil, has had a knock-on effect through the rest of the economy.

Meanwhile, even as inflation begins to rise, UK interest rates remain at an all-time low of just 0.25%.

As inflation rises, we believe the Bank of England will consider tightening monetary policy, which in turn would increase pressure on bond pricing, particularly towards the long end of the maturity spectrum. Now more than ever we think it makes sense for investors to consider inflation protection strategies for their portfolios to preserve the value of future cash flows.

David Hooker – Insight, a BNY Mellon company

The return of inflation has been one of the dominant themes since the start of the year. Economic data in Europe and the US have both surprised on the upside while in the UK fears of deflation, which were so much a part of 2016, now seem a long-distant memory. This is borne out by the latest figures from the … read more

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The natural resources inflection point

Since March 2016 three events have built a floor under commodity pricing. OPEC’s agreement to cut production was one: On 30 November, the cartel reached a firm decision to reduce output by 1.2 million barrels per day. A second key event was the election of President Trump. We expect leadership changes at the Environmental Protection Agency (EPA) and Federal Energy Regulatory Commission (FERC) to support energy and power market development.

Just as significant was the publication in March 2016 of China’s National Development and Reform Commission’s (NDRC) thirteenth five-year plan.

The plan initially targeted coal; illegal mines were forced to close, and the NDRC restricted the number of days that legal coal mines could operate from 330 days per year to 276 days. With Chinese capacity effectively cut from 5.0 billion tons to 3.2 million tons, a price response began globally given the country’s 50% share of global annual consumption. Prices have climbed 85% higher for thermal coal and 290% higher for metallurgical coal through December 2016.

Taken together this triumvirate of developments has helped catalyse an inflection in commodity prices that in our view will likely continue for years to come.

Robin Webhé – The Boston Company, a BNY Mellon company

Since March 2016 three events have built a floor under commodity pricing. OPEC’s agreement to cut production was one: On 30 November, the cartel reached a firm decision to reduce output by 1.2 million barrels per day. A second key event was the election of President Trump. We expect leadership changes at the Environmental Protection Agency (EPA) and Federal Energy … read more

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Commodities form a link in the virtuous circle for emerging markets

While the fortunes of emerging markets are not solely tied to the outlook for commodities, the recent bounce offers yet another reason to be optimistic.

The rally in commodity prices over the past six months has been fairly broad based and this will have an obvious benefit to commodity- exporting countries as, all things being equal, one would expect higher nominal exports to translate into stronger economic growth for export-dependent economies.

Rising commodity prices can help improve these countries’ balance of payments position and, in turn, reduce current account deficits. Currencies of commodity exporters are also likely to be well supported, something which could potentially raise the appeal of local currency strategies.

Since the end of last year, key exporters. such as Russia and Brazil, have demonstrated a strong pick-up in economic growth. But other major importers, such as China, are also faring well, highlighting the positive effect of other key themes at play in the emerging world.

Global data across both the developed and emerging world continue to improve—marking the first co-ordinated cyclical upswing for many years. The cyclical growth backdrop remains supportive for emerging market assets and current conditions have historically been associated with increased capital flows in to emerging economies. In combination, these factors could override the dampening effects of political and fiscal uncertainty stemming from the developed world.

Rodica Glavan – Insight, a BNY Mellon company

While the fortunes of emerging markets are not solely tied to the outlook for commodities, the recent bounce offers yet another reason to be optimistic. The rally in commodity prices over the past six months has been fairly broad based and this will have an obvious benefit to commodity- exporting countries as, all things being equal, one would expect higher … read more

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Where will Trump find tax-cutting wriggle room?

Since Donald Trump’s election, the markets have been abuzz on the transition from monetary to fiscal stimulus. President Trump has promised tax reform, both personal and corporate, as well as “yuge” fiscal stimulus and a lower overall budget deficit. But how much room does the new administration have to manoeuvre?

President Reagan argued for a tax cut based on high marginal tax rates that dissuaded people to work. But the marginal tax rate was 69% when Reagan took office in 1981. The highest marginal tax rate today is 40%. Between Presidents Reagan and George H. W. Bush the marginal tax tumbled from 69% to a modern low of 28%. Will a drop from today’s 40% make a difference and increase tax receipts? Can President Trump afford to drop the marginal tax rate as low as 30%?

The fiscal deficit during earlier tax cuts started from smaller deficits. With today’s deficit at -3.5% compare that to a +1.9% surplus during President George W. Bush’s tax cut and -2.2% deficit during Reagan’s first tax cut, does President Trump have much wiggle room on a fiscal balance sheet that has yet to recover fully from the global financial crisis? Will the fiscal hawks in the US House of Representatives lower their guard for the sake of party over principles? These are questions that remain unanswered but one aspect is clear: the current US budget context seems more restrictive than any in recent memory.

Karsten Jeske – Mellon Capital, a BNY Mellon company

Since Donald Trump’s election, the markets have been abuzz on the transition from monetary to fiscal stimulus. President Trump has promised tax reform, both personal and corporate, as well as “yuge” fiscal stimulus and a lower overall budget deficit. But how much room does the new administration have to manoeuvre? President Reagan argued for a tax cut based on high … read more

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Who are the potential winners and losers of fiscal stimulus?

The constant imperative to support indebted markets hasn’t allowed capacity to be removed; nor has it reduced debt, although it has made debt more sustainable (as interest rates have been reduced). Politicians and their central bankers are unable to break this cycle. Defaulting on debt or causing mass unemployment is not a vote winner, and the rise of populism makes it increasingly unlikely that the authorities will change direction in the near term.

So when does this cycle to ever-lower yields end? If loosening monetary policy is the only tool being used, then it could come to an end when the policy becomes counterproductive. The move to negative rates, and the crowding out of investors from the bond markets, suggests we may be reaching that point. Given the inherent self-survival characteristics of politicians, it looks like they want to try a different tack – fiscal stimulus.

Tax cuts and the loosening of the relentless increase in regulations could reignite some of the ‘animal spirits’ that have been lacking since the financial crisis. Economic growth could be supported and investment reignited with government investment in infrastructure. As a result, government debt would increase, but this would be funded by the central banks, who print money to pay for the debt.

There are a number of issues with this type of approach. First of all, are governments good at leading investment trends? The current idea may be to invest in existing transport infrastructure (owing to its poor maintenance) when, actually, building electric charging stations and improving grids and electricity production may be better as we shift towards electric cars.

Another issue could be that not all populations will respond to an increase in government spending positively. In Japan, for instance, there have been 42 fiscal programmes since the economic peak in 1989, but each time there has been a temporary pickup in activity before the consumer has decided to increase savings and the economy has fallen back.

Finally, if many governments try this at the same time, it will cause a global increase in capacity and inflation won’t necessarily rise.

To learn more about the challenges facing investors, and whether fiscal stimulus could really be the answer to a tepid returns environment download the full whitepaper

Paul Brain – Newton, a BNY Mellon company

The constant imperative to support indebted markets hasn’t allowed capacity to be removed; nor has it reduced debt, although it has made debt more sustainable (as interest rates have been reduced). Politicians and their central bankers are unable to break this cycle. Defaulting on debt or causing mass unemployment is not a vote winner, and the rise of populism makes … read more

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