(London): Aviva Investors’ second-quarter outlook is forecasting strong growth and a sustained pickup in inflation this year.
The firm has raised its global growth expectations to close to four per cent, the fastest rate of increase in seven years. The move was driven mainly by an upward revision in the outlook for the US, although prospects for the UK, Eurozone, Japan and Canada are modestly higher. Stronger wage growth and inflation are expected to follow. Aviva Investors predicts inflation will reach two per cent in advanced economies in 2018.
Most advanced economy central banks are expected to begin or move towards tightening over the next year. The Federal Reserve is expected to raise rates four times, with a further four hikes on the cards for 2019. The pace is more rapid than expected at the end of last year and would take the policy rate to over three per cent.
As markets absorb steps towards normalisation, more volatility will emerge and risk premia will re-price to better reflect fundamentals. Near-term risks have increased with the rise in trade tensions. While the expected scale of US tariffs will probably not be enough to have a material economic impact at national or global level, the recent sell-off in risk assets demonstrated market concern over trading relations.
Looking further ahead, risks are more likely to focus on debt markets. Duration will be challenged by tighter monetary policy, and valuations in corporate credit are already stretched.
Ahmed Behdenna, senior strategist at Aviva Investors, said:
“A higher volatility regime is arguably a good thing for global markets. The robust growth backdrop, which is expected to continue, is helping markets to stand on their own two feet again. The almost uninterrupted rise in equity markets, accompanied by extremely low volatility, has been less healthy. We think that global markets have regained some ability to price risk. There is some differentiation to be made across asset classes once more.”
Latest asset allocation views from Aviva Investors:
Small reduction in equity exposure, although remain generally constructive on global equity markets: An expectation of a higher volatility regime led to a small reduction in equity exposure, although overweight positioned retained.
Revised US underweight to neutral: This decision comes as earnings growth is set to remain strong, with share buy-backs potentially providing more support to the market. To accommodate this adjustment, exposure in other markets has changed, with a slight reduction to Europe and Japan.
UK underweight: Remain underweight UK equities as uncertainty around Brexit still makes the risk-reward balance unattractive.
Aggressively underweight duration in developed markets: The return of inflation and changing monetary policy mean that an aggressively underweight duration position in developed markets is an alternative way of positioning for strong growth. The most acute threats for duration lie in Japan and the Eurozone for sovereign bonds.
Favour emerging market equities and local emerging market debt, and upgrade hard currency EMD to neutral: Emerging markets is the preferred area in equities and local currency debt. Strong growth and, crucially, a benign dollar, combined with still supportive valuations, means that emerging market assets continue to look attractive. Still prefer local currency debt to hard currency debt on valuation grounds. However, as we reduce exposure further in developed market fixed income, we upgrade hard currency debt from underweight to neutral.
Corporate credit , strong underweight: As spreads remain relatively tight, the asset class offers little expected return going forward, most notably in the US and in Europe.
The full document can be read here.
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