Strategy blog: Are we nearly there yet?


It was way too soon to say, as many have been, that the inflation surge is permanent – after just a year.

But it is also too late now, despite the market response to the soft October US CPI, to say it is transitory.

Teams transitory and permanent have both overstated their cases. We are unashamedly in the middle of the road: as we see it, today's inflation is a bit of both. We do expect Western inflation to slow markedly, and soon; but we do not expect it to return sustainably to target for a long time.

Of course, when you stand in the middle of the road you risk being run over from both directions. And it leads to more nuanced investment advice.

If inflation really were going to be (say) 10% forever, the advice would be clear: we should sell bonds and stocks across the board. Ditto, if it were going straight back to the targeted 2% without passing "Go": we should buy bonds and stocks.

But if it's going to subside gradually, at different rates, perhaps not in a straight line, and not get back to where it started, then some assets and regions will look attractive before others, and things may feel, even for long-term investors, uncomfortably tactical for some time.

Our response to the data has been to finally close completely a long-standing aversion to US government bonds – we would switch some cash into them. It is still too soon to say definitively that inflation and interest rate risk have peaked – there was a "false summit" in the spring remember – but with bond yields having risen a long way, and much of the US yield curve now offering a good chance of matching or beating what we think might be the likely inflation trend, we think the risks facing US bonds are more balanced now than for many years.

We think it is too soon to say the same in Europe. Yields are lower, inflation is currently higher, currencies have been weaker (though that can change) and the monetary policy cycle is less advanced: we would still prefer cash to bunds and most gilts.

After much deliberation, and knowing that markets often "look across the valley", we also think it is still too soon to advocate owning more equities than usual. The local stock market response to the US CPI was remarkable, but likely flattered by an earlier sell-off reportedly triggered by volatility in cryptocurrencies (yes, me too!). As noted, the data itself was not that decisive; central banks – including the Fed, for a while at least – will continue to raise policy rates; and corporate earnings risk remains elevated (as, of course, does geopolitical risk).

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