Will we see overheating and inflation in 2018?
15 January 2018
How might 2018 is going to unfold? Anthony Rayner, manager of Miton’s multi-asset fund range, looks at the economic and market situation
The economic growth data has been knock-out so far this year – growth is strong and synchronised across developed and emerging economies. This follows a very strong 2017 and, if this economic momentum continues, the key question is to what degree it leads to economies overheating and what it means for inflation.
Consumer price inflation currently remains pretty muted across most developed economies. The UK is the exception, though even here it’s nowhere near rampant, and has been driven largely by the pass-through effect of a weaker sterling, the impact of which is starting to fall sharply.
The oil price is up materially, almost 50% in six months, testing 2015 highs. This is important because oil remains a major input into the global economy despite new energies and increasing efficiencies with existing energy sources and, as a result, is a key driver of inflation. Indeed, the higher oil price has helped push market expectations of US inflation higher.
The degree to which a higher oil price is driven by an increase in demand is difficult to gauge. However, tighter supply has had an impact too, driven by OPEC extending their supply cut and, to some extent, domestic tensions in key oil supplier, Iran.
Clues for 2018
Where else can we look for clues as to how 2018 is going to unfold? The fourth quarter corporate earnings season starts this week and it’ll be interesting to see how many companies mention wage pressures. In the third quarter, 8% of S&P 500 companies mentioned higher labour costs, the largest number in a year. Most frequently, retailers mentioned higher wage costs, in part driven by minimum wage increases, and the housebuilders, which have experienced labour shortages.
As such, labour intensive industries are areas to watch, as is the persistency of the move higher in the oil price. In fact, persistency of forces more generally is crucial, in short, whether inflationary pressures are likely to be one-offs or sustained. For example, if we see a broadening of labour shortages, this would be more worrisome than, say, the weakness of sterling post-Brexit, which looks to be fairly isolated.
How this plays to central banks will also be key, as they try to stage manage their QE exit. It seems that, in the absence of meaningful consumer price or wage inflation, managing asset prices is currently at the top of their worry list. The complexity of this task will increase materially if inflation starts to force their hand.
In the meantime, we retain our base case of strong growth and inflation, and interest rates that are edging higher. In portfolios, we are emphasising economically sensitive equities, short duration, good quality corporate bonds, and a burgeoning exposure to inflation beneficiaries. This is complemented by our thematic exposure, taking in areas like new energy, robotics and technology in healthcare, which help to act as a diversifier to the macro base case.
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