(London): Fundamentals are exerting greater influence on asset prices as sustainable and broad-based growth becomes entrenched in the global economy, according to the third-quarter House View from Aviva Investors. As central banks continue to roll back the extraordinary stimulatory measures that followed the global financial crisis, markets are moving closer to normalisation.
The US Federal Reserve has raised rates four times since December 2015, with a further four hikes expected by the end of 2018. The European Central Bank has tapered asset purchases and is discussing its exit strategy, while the Bank of Japan has indicated it is unlikely to expand its radical stance any further. Even in the UK, some policymakers argue that interest rates should be higher due to the recent spike in inflation.
Global GDP growth could be around 3.5% this year, the fastest growth rate since 2011. Above-trend growth in the major economies – the UK is the exception - should put modest upward pressure on wage growth and core inflation.
Ian Pizer, Head of Investment Strategy at Aviva Investors, commented:
‘After a remarkable decade for monetary policy, we are reaching a significant turning point for central banks. With sustainable and broad-based growth entrenched, and the return of more convincingly-positive inflation, the slow removal of extreme stimulus is now becoming appropriate.
Bond markets are sceptical about policymakers’ ability to reach inflation objectives, however, with last year’s reflation trade largely being unwound. Investors are concerned because recent inflation releases have shown modest declines, casting doubt on the underlying positive trend. Longer-term bond yields have retraced and speculative long positions in US Treasuries are at all-time highs, despite the Fed hiking US rates for the second time this year in June.
While the benign global risk environment has been supportive for government bonds, we think the risks are for higher yields in the second half.
Global equity markets are at or close to new high, in part reflecting significantly improved earnings growth. The accompanying positive re-rating is highly unusual in the middle of the US rate hiking cycle, but likely reflects continued excess liquidity and the collapse in market volatility. European and emerging market equities remain relatively more attractive on earnings and valuation grounds.
With a further narrowing in spreads, credit has become relatively less attractive. Emerging market debt offers better opportunities, particularly in local currencies, which should continue to benefit from improved fundamentals and a carry-supportive environment.
The dollar is likely to remain fairly range-bound in the near-term, the euro could potentially move higher and the yen might weaken. Positive carry emerging market currencies will continue to perform well in a low volatility environment.’
Read the report here:
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