Beware of the unexpected

At the beginning of February the question on the lips of investors was whether the return of volatility presaged an end to the bull market or was merely a correction, following a sustained period of rising equity markets.

So far the correction story seems to be holding good. Global economic growth continues to build and even geo-political issues have retreated a little, with conciliatory noises coming out of North Korea, though the troubles in Syria rumble on.

While important economic statistics are rather thin on the ground right now, analysts have been poring over such available data that could indicate how inflation will fare in the weeks and months ahead. Rising inflation usually leads to higher interest rates. Already there is expectation that the US Federal Reserve Bank, under its new chairman, Jerome Powell, could make three further rate increases this year. In a way that would be good news as it suggests the improved economic background there is considered secure, but it reflects inflationary fears.

The belief that the cost of living could be on the up around the world could dampen enthusiasm for equities in the short term, though in truth shares are more likely to be a beneficiary. It is bonds that are most vulnerable. Ten year government bond yields in the US are approaching 3% - nearly double what they are here and four times the German rate. Behind this rise in yields is an expectation that central banks will inevitably become more hawkish in their approach to monetary policy.

Most governments and central banks like a modicum of inflation. Indeed, Japan has been trying to encourage it, with limited success it has to be said. Our own Bank of England has been set a target of 2% annual inflation so, with  our own Consumer Price Index coming in at +3% last month, a little higher than expected, we are ahead so far. With government and personal debt an increasing concern, modest inflation would have the beneficial effect of devaluing this debt.

With inflation back on the agenda, there is now speculation that interest rates could rise here, perhaps as early as May. It all gives investors something new to worry about, though actually economic news is generally robust, with the European Union growing more strongly than previously thought. The big picture still looks rosy. It is the unexpected of which we need to be wary.

Understanding Finance

Helping clients understand what we do is key to building relationships. To explain some of the industry jargon that creeps into our world, we’ve pulled together a section of our site to help.

Related articles

How does the seasons and holidays impact markets? Has this year been any different so far?

The pound fell after hearing Hunt’s Autumn Budget. What other impacts did it have on the markets?

James Godrich discusses why he prefers non-commoditised businesses.