Where’s the inflation?
For each of the last four years, Q1 has had a consensus. This consensus revolves around the return of inflation, sharply higher yields and a more aggressive Fed. The reasons have been different. Q1 2017 was about commodity inflation; 2018 was about wage pressure, but in each of the past four years, the market has quickly turned around and said, “Where is the inflation?”
For each of the last four years, the market has dramatically overestimated the potential for a permanent inflation jump, with expectations generally peaking in Q1. The pattern appears to have repeated itself in 2018, with US wage inflation remaining under control and Chinese CPI and PPI heading lower.
The onus is not on the inflation doves like myself to continue to prove that inflation pressures remain muted. It is up to those who believe that we are entering a bond bear market to show the rest of us that inflation has returned. The market continues to under-estimate the strength of technology and western demographics as structural disinflationary forces.
Our best tactical trade for the quarter was buying US 10-year bonds with yields above 2.90%. While sitting in the tactical bucket currently, I remain convinced that long dated yields will not move above 3% over the course of the next several years. The disinflationary forces that are capping yields are here to stay.
The Fed remains a side show, with a strong likelihood that we will only get two more hikes in 2018. This scenario would be very supportive of global risky assets for the balance of the year and cap the back end of developed market yield curves. I could easily see a scenario where 2’s / 10’s get close to inverting as we approach the end of the year. This would be less of a sign of a pending recession and more of an indication that the world is chronically short of quality yielding assets.
Founder, View from the Peak
IND-X Advisors Limited