Investment Clock insights

Rising inflation creates positive backdrop for stocks


Trevor Greetham

1 November 2016

Better than expected economic data in the UK has seen gilt yields rise back to pre-referendum levels. However, rising government bond yields are not a UK-specific phenomenon.
Bond yields have risen sharply in the US, in Europe and in the UK in recent weeks but, interestingly, inflation protected bonds have not participated in this trend (see chart below). This means bond markets are not reflecting fears of tighter monetary policy. Rather, the rise in yields is attributable to a rise in long-term inflation expectations.
The global bond sell-off reflects a worldwide willingness to let inflation run higher from its current low level and this creates a positive backdrop for stocks over the medium term.
Bank of England governor Mark Carney has said he is willing to let inflation rise rather than tightening policy as the negative impact of Brexit negotiations hits the economy. US Federal Reserve chair Janet Yellen has also been reluctant to raise rates, despite the low unemployment rate.
In both cases, central bankers point to downside risks to the economy from high levels of national and personal debt. In reality they have a strong incentive to allow inflation to overshoot to help reduce the burden of debt on the economy.
When nominal growth is picking up, commodities and equities tend to do well at the expense of bonds and cash: this preference is reflected in our multi asset Funds. With growth positive and policy likely to stay loose, we remain positive on global stocks, especially in the emerging markets and Japan.

Better than expected economic data in the UK has seen gilt yields rise back to pre-referendum levels. However, rising government bond yields are not a UK-specific phenomenon.

Bond yields have risen sharply in the US, in Europe and in the UK in recent weeks but, interestingly, inflation protected bonds have not participated in this trend (see chart below). This means bond markets are not reflecting fears of tighter monetary policy. Rather, the rise in yields is attributable to a rise in long-term inflation expectations.

The global bond sell-off reflects a worldwide willingness to let inflation run higher from its current low level and this creates a positive backdrop for stocks over the medium term.

Bank of England governor Mark Carney has said he is willing to let inflation rise rather than tightening policy as the negative impact of Brexit negotiations hits the economy. US Federal Reserve chair Janet Yellen has also been reluctant to raise rates, despite the low unemployment rate.

In both cases, central bankers point to downside risks to the economy from high levels of national and personal debt. In reality they have a strong incentive to allow inflation to overshoot to help reduce the burden of debt on the economy.

When nominal growth is picking up, commodities and equities tend to do well at the expense of bonds and cash: this preference is reflected in our multi asset Funds. With growth positive and policy likely to stay loose, we remain positive on global stocks, especially in the emerging markets and Japan.

Source, Bloomberg & Datastream

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.