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Watch out for inflation in the US as a portfolio disruptor

Investors in Europe tend to be overwhelmingly focused on the risk of deflation. However, on the other side of the Atlantic inflationary pressure is building, and the Fed is more than happy to accommodate that, fund managers at Expert Investor Lisbon warned.

There is a strong consensus among European fund buyers that bond portfolios will return between 0 and 2% over the next five years, and that deflation is a far greater threat than inflation now. The Portuguese are no different, with three quarters of delegates at Expert Investor Lisbon fearing deflation the most and two thirds advising their clients against buying (Portuguese) government bonds at the moment.

While inflation indeed seems some way off in Europe and is therefore not an immediate issue from a purchasing power point of view, investors’ holdings in the US would be affected if inflation inches up there. And this is a very real prospect, said Stephen Marsh, a fixed income specialist at T. Rowe Price, calling it the second most serious risk for investors at the moment after Brexit.

Inflationary Fed

“Inflation could sort of pick its head up in the next year when you see the oil price bounce back and see wage inflation pick up,” he said. But the main factor at play here will probably be the Fed, according to Marsh. “They prefer tackling inflation than deflation,” he said. “I heard the Fed member from Chicago [Charles Evans] say recently in Hong Kong inflation would be an easier problem for them to deal with than deflation.”

Chris Childs, multi-strategy director at BMO Global Asset Management, agreed that a rise in inflation in the US is something investors should take into consideration. “Inflation is something people aren’t talking about, but you have to cognoscente of that risk, especially because of the initial impact on bond markets,” he said.

 

 

Increasing inflation without an accompanying uptick in economic activity could culminate into a vicious circle particularly damaging to multi-asset portfolios, said Childs, concluding: “From a multi-asset fund manager perspective, your main risk is in equities. Those could be upset by the bond markets, which by then will have lost their capability to act as your hedge [as they are affected by rising inflation].”

Not all fund managers speaking in Lisbon were as concerned about inflation in the US though. “Wage growth is the primary driver of inflation in the US. However, there is still quite some slack in the labour market in the US when you look at the participation rate,” said Boston-based Nicholas Paul of MFS Investment Management. “So I’m not overly concerned about deflation. The biggest market risk for me is [the lack of] corporate earnings.”  

Click here to see a full overview of delegate voting results from Expert Investor Portugal.

And here you can see a selection of photos taken at the event.

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