Global inflation inflexion point plants seeds of US ruin

Dan Purves

By

28/02/2017

Global inflation has reached an inflexion point that, when combined with new President Trump’s policies, is planting seeds for the destruction of the US economy by 2020, a range of experts has told the PortfolioConstruction Forum Financial Markets Summit.

In February, US equities reached a record high and the US dollar was stronger but US Treasuries were selling off, partly in response to the stimulus side of the Trump plan. His policies, despite contributing to a strong equity rally, are predicted to be inflationary and to fail to achieve his aim of 4 per cent growth.

Multiple presenters at the summit laid out a similar scenario for the next four years, but cautioned that the tails on the right and left were much fatter, making a moderate outcome less likely to occur.

“Many people, including some of the biggest investors on Wall Street, have argued that Trump is an accelerant adding fuel to the fire of inflation,” Stanford University Hoover Institution fellow Niall Ferguson said.

He added this was problematic from a fiscal point of view, given the relatively short time to maturity of the federal debt; it would not take long for higher nominal rates to feed into higher borrowing costs for the US federal government.

The gross federal government debt is $20.1 trillion, well above the suspended $18.6 trillion debt ceiling. The suspension will end on March 16, meaning Congress will have to vote to extend the suspension, raise the ceiling, or force the Treasury to take extraordinary measures to avoid a default.

“The Congressional Budget Office has said in its analysis that Trump’s policies are estimated to add to the US economy [debt equal to 30 percentage points of GDP over the next 10 years, moving debt as a percentage of GDP] from roughly 75 per cent now to 105 per cent. That threatens the US AAA credit rating over time,” Colonial First State Global Asset Management chief economist Stephen Halmarick said.

If Trump follows through on his plans for big fiscal expansion, it could well show up mostly as inflation rather than output growth, because there is little spare capacity, PIMCO managing director and global economic adviser Joachim Fels added.

“Markets have already priced in higher inflation, but we think that’s not enough. We think inflation has further to run, particularly if we get the fiscal stimulus,” Fels argued.

The increased hawkishness from the Federal Reserve could also add inflationary pressures, particularly if it responds by tightening monetary policy too much or too early, pushing up bond yields.

“The higher bond yields, the stronger dollar and the higher interest rate from the Fed will all [contribute to] a slowdown in the US economy and markets, probably into 2020, which would probably be the worst timing for Trump,” Halmarick said.

Fels added inflation is more likely to surprise on the upside than on the downside but, even in a left-tail scenario, with a trade war there would be higher inflation because import prices would rise in response to higher tariffs.

“We think it makes sense to buy insurance against inflation and my main message to you is to ignore left-tail risks at your peril,” he said.




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