Global economic growth is now at its strongest and most synchronised since the 2008 financial crisis and, as if adding fuel to the fire, Donald Trump’s tax cuts have provided a further boost.
However, paradoxically, this makes us more, rather than less, concerned about the outlook for both equity and bond markets.
After one of the weakest recoveries on record, strong economic and profits growth is finally starting to feed through into rising wages. As the chart shows, leading indicators of US wage growth, are now pointing to wage inflation returning to, or exceeding, the levels seen before the financial crisis.
Whilst this is undoubtedly good news for workers, it poses a growing problem for those charged with setting the appropriate level of interest rates.
With unemployment in the US now closing in on the low rates last seen in the 1960s, which ended with a sudden shift to a far more inflationary world, we believe the US Federal Reserve will soon find itself in the difficult position of being ‘damned if they do… and damned if they don’t’.
If the Fed raises interest rates faster or further than the market currently expects, then there is a real danger that this is more than an indebted global economy can tolerate, and certainly more than fragile financial markets can bear – just look at how stock markets reacted in February.
However, if the Fed shies away from tightening financial conditions sufficiently, fearful of the impact on both the financial and real economy, then inflation pressures are likely to mount and both equity and bond markets could sell off regardless.
At Ruffer we hold index-linked bonds to protect against higher inflation, but the road to this inflation could be bumpy. We fear markets may get more, rather than less, dangerous as the year progresses.
Chart source: Bureau for Labor Statistics, NFIB, Regional Federal Reserve Banks, Ruffer LLP