The Australian economy continues to benefit from strong net exports and infrastructure spending.
The level of US households expecting income growth continues to hover around 18-year highs. This has historically been a good guide of future wage inflation.
- Christopher Hindmarsh
GDP growth in the March quarter was the fastest since 2011, rising one per cent over the quarter or 3.1 per cent year-on-year boosted by solid LNG exports and government spending.
However, the unemployment rate has remained steady at around 5.5 per cent over the past year, which has meant that wages and inflation have been slow to rise.
Geopolitics came back into the spotlight as the dominant theme during May.
Markets found themselves having to contend with a fluid political situation in both Italy and Spain.
As well as the on again-off again meeting-to-end-all-meetings between United State President Donald Trump and North Korean leader Kim Jong Un.
On top of that the US backing out of the Iran nuclear deal, and last minute steel and aluminium tariffs imposed by the US on the EU, Canada and Mexico.
The latest jitters in Italy flowed through to US interest rates in a predictable manner: 10-year US Treasury bond yields fell from around 3.10 per cent to around 2.80 per cent.
However, medium term, we are increasingly comfortable with the view that 10-year bond yields rise over three per cent in a sustained manner.
In particular, one driver of rising interest rates will be wage inflation.
The level of US households expecting income growth continues to hover around 18-year highs.
This has historically been a good guide of future wage inflation.
The latest monthly wage data in the US showed an increase in annual growth to 2.7 per cent.
With the US unemployment rate printing at the equal lowest level since 1969, I think there is further to run in wages, which in turn will keep the Fed in tightening mode.
Bond yields globally have been trending higher over the last nine months, most acutely in the US.
Uncertainty around the recently-elected government in Italy caused a “flight to safety” with sovereign bond yields outside of peripheral Europe dipping sharply.
However, we see this drop in bond yields as temporary, given global growth remains solid with building inflationary pressures as many economies are now encountering capacity constraints.
Recent commentary from US Federal Reserve officials has suggested that with inflation back to around their target of 2 per cent per annum they need to continue to neutralise interest rate policy so that it is no longer stimulating the economy.
However, I expect this means that the rise in interest rates and yields should be relatively orderly even if inflation rises sustainably above 2 per cent in the short term.
At this point, I remain underweight fixed income but feel that we are getting close to the point where it no longer makes sense to hold an underweight exposure.
Bond portfolios can still deliver reasonable returns even if yields climb a little higher over the next 18 months.
- This article does not take into account the investment objectives, financial situation or particular needs of any particular person. Accordingly, before acting on any advice contained in this article, you should assess whether it is appropriate in light of your own financial circumstances or contact your financial adviser. Christopher Hindmarsh is an adviser at JBWere Limited. JBWere Limited is owned by National Australia Bank Limited.
