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Damned if they do… damned if they don’t

Wage inflation in the US poses a growing problem for the Fed
The Green Line
Steve Russell
Investment Director

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.

Quantitative tightening – what might it mean?
May 2018: Shrinking central bank balance sheets could undermine record asset prices
Read
Why traditional safe havens might not work
April 2018: In the market sell-off this February, defensive assets failed to defend.
Read
Japan: a forgotten market?
March 2018: Japanese shares have risen strongly, but not nearly as much as company profits.
Read

Chart source: Bureau for Labor Statistics, NFIB, Regional Federal Reserve Banks, Ruffer LLP

our thinking
Inflation: bad for portfolios, good for society?
As inflation has soared to its highest level for 40 years, financial markets have taken fright, with most bond and equity markets down significantly so far in 2022. In fact, the US is now officially in a bear market, and inflation pressures show few signs of fading – quite the contrary.
Swimming naked
July 2022: It is hard to overstate how far free and unlimited central bank liquidity has rewired the financial system. As central bankers extract themselves from the monetary rabbit hole they have burrowed their way into, the damage to traditional portfolios is likely to be considerable. This tightening of monetary policy is happening because inflation has returned – with a vengeance.
Ruffer round up – Q2 2022
July 2022: Investment Director Duncan MacInnes joins Rory McIvor for a review of the quarter, discussing the scale of wealth destruction across markets and how they see this rippling out into real world behaviour, and looking forward to what could be on the horizon and what that means for investors.
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Investment Review
July 2022: Jonathan Ruffer explains why wage demands are the final element required to fuel the new inflationary epoch. This regime will be good for social mobility in the long run, with the workforce and innovators as the winners. But it might well be brutal for the investment community.
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OUR THINKING
London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France