The message that the “US Federal Reserve is behind the curve” is resonating with some investors, who fear 1970’s like inflation is making a comeback. I personally believe that inflationary outlook is benign and will likely stay as such. The high inflation witnessed in the 1970’s was underpinned by three key factors – GDP growth averaged 4-5%, the unemployment rate was as low as 3.5% and, most crucially, the labour force was highly unionized. In a unionized labour force, wage increases are easily met and indeed passed on by the producer to the consumer, in the form of higher prices at the till. Over the past fifty years, the power of unions has been greatly reduced in the US. Italy is in a triple-dip recession due to lack of reforms. Lack of reforms scare off new investors, as well as stop existing investors from spending. Italy’s “significantly low” level of private investment is a direct consequence of the absence of reforms and the lack of clear government policy and is not due to the cost of capital. The ECB has intensified preparatory work related to outright purchases of Asset-Backed Securities (ABS). The ABS purchase rhetoric from the ECB raises the likelihood of it actually happening. In my view, the risk light on equities is still green but with some flashes of amber. I remain bullish on equities until at least the September Fed meeting and will then reassess. The comments from this meeting will help me decide if the light goes from amber back to green or from amber to red.
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