Speaking at an adviser roadshow in Sydney yesterday, Vanguard Asia Pacific chief economist Qian Wang made the case for an inflation ‘surprise’ in 2018 that could catch markets unaware.
Inflation has remained stubbornly low in developed countries in recent years, despite 80 per cent of the global economy sitting at or just below full employment, Ms Wang said.
Economist are scratching their heads at the current lack of wage growth in major economies – something that has historically been linked with falling unemployment.
But Vanguard is tipping that wage growth (and hence inflation) will begin to emerge when US unemployment falls below 4 per cent later this year.
There are also signs that inflation is emerging in Europe, Japan and China, Ms Wang said.
“If we have an inflation surprise and if we have the global growth picture look pretty solid, the US Federal Reserve will feel comfortable to go ahead and with its hiking [ahead of market expectations],” she said.
The market is expecting the Fed to hike three times in 2018, but if US inflation hits 2 per cent, that could increase to four rate rises for the calendar year, Ms Wang said.
“In that case, the bond market will be busy reassessing their expectations for interest rates and break-even inflation,” Ms Wang said.
Better-than-expected US job numbers in early February were enough to cause US Treasury yields to spike, leading to an (albeit short-lived) equity market correction in the ensuing days.
But Ms Wang emphasised that Vanguard is expecting an inflation ‘surprise’ rather than a ‘scare’ at a later point this year.
“We are expecting higher financial risk, but not an immediate financial crisis. And we are expecting central banks to be tougher, but not ‘killers’. If that is realised, it's not a bad scenario for financial markets,” she said.
“We can expect another good year in the financial markets, because no matter what, the fundamentals are still solid – suggesting continued earnings growth from the corporate sector,” Ms Wang said.
