deVere Investor Insight - Q1 2021

Investor Insight // Q1 - 2021 37 The nightmare scenario is of structural global bear market in bonds emerging, reversing a 40-year trend of rising prices (and falling yields). What could trigger this? All eyes are on wage growth, because if wages rise in response to increased inflation expectations, a return to the wages/prices spiral of the 1970s is possible. This could easily trigger a sell-off in risk assets (such as equities), if rising borrowing costs and wage bills curtail output, and hurt the recovery in corporate profits. But wage growth is flat in the U.S, held down by unemployment at over 6%. Instead, the inflation we have seen in recent months appears to be more benign. It reflects an upturn in energy prices and disrupted supply lines in manufactured goods, rather than a structural increase in demand. These supply-side shocks tend to be deflationary in their effect on the broader economy, since they reduce spending elsewhere. It may be that the resumption of ‘normal’ economic activity triggers the release of pent-up demand, fuelled by the build-up over the last year of household savings and -yes- Biden’s $1.9 trillion spending plan. But while a temporary boom in demand will raise prices, it seems unlikely that this will translate into higher wages given the quantity of unemployed and underemployed in the U.S, and much of the developed world. It seems more likely that any increase in prices caused by demand factors will cause a temporary blip in inflation. The risk of a temporary burst of higher prices triggering a wage-driven inflation spiral seems small. Therefore, a great reversal to the bond market does not seem likely. This goes some way to explaining the limited impact, so far, that higher government bond yields have had on other asset classes. As well as the fairly modest numbers that economists are attaching to their warnings of inflation. JP Morgan Asset Management, for instance, are forecasting a return to approximately 2% inflation in the U.S over the coming years. Certainly, this is an increase on the 1.4% seen in January of this year, but 2% will only take inflation up to the Fed’s target rate. JP Morgan Asset Management’s forecast rise in bond yields is similarly modest, with the 10-year Treasury peaking at around 3% in the current economic cycle. Again, quite an increase from today’s 1.6% but well below yields seen during previous economic cycles and suggesting very low (though positive) real bond yields. The nightmare scenario of wage-driven inflation appears unlikely

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