I…For Inflation, R…For Rates

Signs of a future increase in inflationBalloons at Dawn

Signs of a future increase in inflation are becoming increasingly visible. Natixis IM explains some of these clues. In the US, long-term inflation outlook, which is currently situated around 2 – 3%, is now trending clearly higher. This is visible notably in long-term inflation outlook among companies measured by the anticipated rise in hourly labour costs (+2.2% vs +1.8% on average from 2015-2017).

In another tangible sign of this necessary redistribution of value, Amazon has decided to increase its hourly wage rate ($15 vs $12.45).

In the eurozone, inflation increased to over 2% over the past few months, driven primarily by higher energy prices. Underlying inflation on the other hand slipped below 1% (+0.9%). Analysts from Natixis IM say:

A recent meeting with a retirement homes group nonetheless provided us with a clear illustration of wage inflation, as the company has been obliged to grant increases of 3 – 4% to its staff based in Germany.

Meanwhile, interest rates reacted to Jerome Powell’s comments regarding a possible acceleration in the rate hike cycle. US 10-year yields steepened almost 20 points (3.23%) while German rates increased by 10 points or so (0.56%). Thursday saw the beginning of heavy sector rotation towards value stocks and banks. A probable Moody’s downgrade of Italy will not necessarily trigger further high volatility in the local bond markets. Long-term rates are already nudging towards the intervention threshold (3.5%-4%).

A downgrade by 3 or 4 of the major ratings agencies would be a disaster scenario however, as it would relegate the country into the non-investment grade category.

At a recent meeting, the CEO of a French bank operating in Italy did not believe that this would be the case. The saga of the Italian budget and even the national government is not yet over however.

History, a faithful and useful companion for fund managers teaches through repetition. It would therefore not be unreasonable to imagine that Italy will perhaps soon have its 66th government.