The three issues preoccupying the markets at present have led to a return of volatility on the financial markets: growth, inflation and the Federal Reserve’s monetary policy.

Has the growth and inflation dynamic really changed?

After all, only a few months ago, investors were still worrying about the weakness of the global economy and the monetary authorities’ inability to achieve their inflation target. Now they seem to be afraid of the US economy’s "overstimulation" and an increase in inflation.

There is no doubt that the US economy has improved in recent months. But its main driver is private consumption which has several concerns hanging over it:

• The fall in the personal savings rate in December to 2.4%, its lowest level since 2005
• Rising interest rates at a time of high debt
• The increase in the oil price

The idea that the bases for a sustainable acceleration in the global economy are finally in place seems unrealistic. On the contrary, the central banks’ monetary policies have prevented an overhaul of the economic situation and the structural brakes on growth continue to be present. What is more, the immigration and trade measures introduced by the US authorities are set to further reinforce these dampers. Finally, a considerable proportion of the economic upswing of recent years has been due to the increase in share prices and property values.

The second important subject for investors concerns inflation

This raises two questions:

Will wage rises escalate?

The unemployment rate in the United States has fallen considerably in recent years and could soon drop below the 4% mark. In the past, such a low rate would effectively have put pressure on wages. However, since the financial crisis, the relationship between the unemployment rate and wage rises has become much less clear.

Will companies pass on potential wage rises to their customers by raising their prices?

It is worth noting that many companies operate in a highly competitive environment and that phenomena such as digitisation and e-commerce often generate downward price convergence.

Deflationary trends caused by the technological revolution are still well in evidence. The real risk in terms of inflation is that one day we will see the surplus cash created by the central banks leave the financial sphere and enter the real economy.

What line will the US Central Bank take?

The third subject for discussion concerns the US Central Bank's actions given the uncertainties surrounding growth and inflation: will the Federal Reserve step up the pace of its monetary policy tightening, to the extent of causing turbulence on the financial markets? Fed Chair, Jerome Powell, has indicated that their decisions will depend on developments in the economic situation. This suggests that the Fed will not be precipitating matters.

In the end, the fundamentals regarding growth and inflation have not changed dramatically in our view. So there is no reason to think that the central banks will adopt monetary policies that are very different from those that have already been factored in. However, this does not mean a return to an environment like last year’s, when share prices soared and volatility was low.

Guy Wagner, Managing Director

An economics graduate from the Université Libre de Bruxelles, Guy joined Banque de Luxembourg in 1986 where he was head of the Financial Analysis and Asset Management departments. He was appointed Managing Director of BLI – Banque de Luxembourg Investments in 2005.

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