Reflation, then inflation, but also growth

Fund manager Unigestion has predicted the returns of inflation, but also higher growth, meaning investors should overweight inflation-linked assets.

It said that inflation-linked bonds and commodities are its favoured assets, while it thinks nominal bonds will suffer. “Our calculations of current fair value based on potential GDP and inflation come out at 2.80% for the US 10-year Treasury and 0.4% for the 10-year Bund. If we add Federal Reserve and ECB forecasts, fundamental fair value is significantly above current levels. We therefore overweight inflation break-evens and commodities (industrial and energy) and underweight sovereigns, particularly in Europe, where they are furthest from fair value because of low inflation pricing and the scarcity of short-dated paper.”

Unigestion said it was also overweighting growth assets, despite heightened political risks, with a preference for developed and emerging market equities, rather than credit. It added that cost-effective currency or defensive value hedges for its equity positions may be needed to protect against political risk. On the case for higher inflation, Unigestion said weaker oil prices were less of a factor due to falling inventories and increased demand. In addition, it said input prices are rising, due to higher wages in China and also due to the rising US dollar. “The trend in developed economies is skewed towards more inflation in the next decade, not less,” Unigestion stated. The final factor supporting a period of higher inflation is a period of higher growth and it added: “In order to see a period of sustained inflation, the world needs positive growth momentum across all regions; we believe we have reached that point.” Unigestion said that higher public expenditure, by the Trump administration and also European governments, either as a result of populism, or in response to it, would increase investment and foster higher growth.