Inflation Outlook Calls the Shots - Perspectives: October 2017
Length 4:12 

Luc de la Durantaye, Managing Director, Asset Allocation and Currency Management, CIBC Asset Management

What we see over the next 12 months is a continuation of global growth at slightly above potential, which helps in a way remove excess capacity in the global economy. And this is at a time where inflation is below most central banks’ targets. So that creates a good growth environment – low, but gradually moving up inflation, which brings an important change in the in the outlook, which is that central banks are moving from quantitative easing policies to quantitative tightening. But they will do so, and they've announced so far that they would do so at a very gentle pace. We see that the Federal Reserve will remove only a third of their accommodation, that they've been giving throughout the expansion, and the ECB will announce that they will only start tapering their stimulus. So overall good growth, low inflation that's slowly moving up only, and a gradual removal of easing, but very gradual, so a good outlook.

Potential risks

This, albeit being a rosy scenario. There are some risks. The place to look for risk is during an expansion you build areas of excesses. The main excess that we can think of is debt. Debt levels, consumer, particularly in Canada, in Australia, Nordic countries in Europe have built large debt ratios and that could become a problem if interest rates rise too fast. Yet debt servicing for consumers are very low, given the low level of interest rates and central banks are very aware of that risk. So we don't think that central banks are going to take a strong risk by raising rates too fast. The other element of risk might be fiscal spending, a bigger fiscal stimulus. We don't think that that's a risk too much in terms of because of the fact that the Congress doesn't have much room to increase the fiscal deficit. And so there are risks but those risks we think for the next 12 months are manageable.

Portfolio impact

So how does this rosy environment play out in the financial markets? Well some of that has been priced in already, which is the tricky part for the next 12 months. Government bonds, given that central banks are removing some of the quantitative easing, are likely to have some sort of a drift upwards. So those would be to avoid. We'd be more neutral on the credit side and the high yield side. On the one hand credit is spreads are very tight. But on the other hand, the good economic environment should continue to support this asset class. Where growth is going to be present, equity markets should do relatively better particularly in the emerging markets where fundamentals have continued to improve. Earnings growth continues to be well supported. Valuations are still attractive. And central banks in emerging markets are actually not raising interest rates. Some have even some room to lower interest rates. On the other, and from a regional perspective, the U.S. continues to look more and more expensive. From a sector perspective, probably given the continued rise in interest rates, interest sensitive sectors should be maybe shied away a little bit, and the more cyclical side of the equity market should probably be emphasized going forward.

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