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Peter van der Welle

If a picture is worth 1,000 words, what value a chart that says it all? Robeco Investment Solutions spends many hours compiling charts to illustrate a current issue. Most are made in-house, while some are externally sourced. We asked the team’s three enthusiastic chartists – Lukas Daalder, Jeroen Blokland and Peter van der Welle – to name one that expertly depicts what they believe will be a major investor issue for 2017.


Chart of 2017 #3: Mind the Gap: Inflation is back

11-01-2017 | Insight | Peter van der Welle Mind the gap: inflation is back

Exceeding expectations

For our third chart extraordinaire in a series of three, strategist Peter van der Welle picked this one entitled ‘Mind the Gap: Inflation is back’. This shows how the gap between the global bond index (blue line) and developed market inflation surprises (orange line) has widened after levels of reported inflation have progressively exceeded expectations in recent months.

“This is one of the essential charts in my recent ‘2017 Outlook’ presentations because it shows that there is more to the reflation trade than the bond market just discounting the implications of ‘Trumponomics’,” says Van der Welle.  “The blue line shows the steady downtrend in the global government bond yield since the financial crisis of 2008, while the orange line shows how inflation surprises likewise sank deeper into negative territory, as the inflation print repeatedly came in below economists’ expectations. They more or less mirror each other until autumn 2015.”

“The potential game changer in this graph is that more recently, inflation surprises in developed markets seem to have bottomed out, and have even become positive. So for once, economists have underestimated the recent inflation prints!”   

So, what’s underscoring this sea-change? “Basically, the orange line depicts a behavioral process, in the gradual emergence of the deflation scare in the market since 2012, which gave the bond bull market new vigor,” Van der Welle explains.

“There were several deflationary forces at work which fed the scare during this episode, including excessive production capacity, significant slack in labor markets, the disruptive impact of new technology, fiscal belt-tightening by governments, increasingly ineffective (un)conventional monetary policy, deleveraging, and last but not least, the oil market rout in autumn 2014.”

“Now, with labor markets tightening, capacity utilization rates trending up, credit growth improving, the oil market rebalancing and governments more skewed towards fiscal stimulus these days, the economy is heading towards the reflation path.”          

Deflationary forces are still here

How this chart develops in 2017 remains uncertain, Van der Welle says. “Not all deflationary forces have vanished: the US dollar is strong, there is still significant slack in the European economy, and prices are falling for existing technology goods. If China keeps depreciating the yuan, this could still remain a deflationary force for the global economy, despite the rising domestic inflation.”

“Therefore, economists and investors will need some heavy convincing that we really are moving away from a deflationary world. And it is precisely this slow adaptation to a different world view, with consensus still expecting fairly low inflation prints in 2017, that will give more room for upward inflation surprises in a world that is actually reflating further, in our view.”

“So, we can expect the orange line to go up further into positive territory next year, and therefore expect bond investors in return to ask for additional compensation for inflation, leading to somewhat higher yields. Rising yields are bad news for bond investors, but it is important to note that the move away from a deflationary scenario never will be smooth.”

“And there is more to bond prices than just inflation. With a very busy European election agenda, the rise in populism, the uncertainties surrounding Trumponomics, still-high sovereign debt levels and some central banks (such as the ECB and Bank of Japan) remaining active buyers in the bond markets, yield rises are likely limited.”

Peter van der Welle

Strategist
"Applying the right filter to the available market information is vital in our profession: What is a signal and what is noise?"
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Peter van der Welle
Strategist


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