• A week of little economic news and low market volatility saw further outflows from mutual funds, gently nudging up most asset classes –– equities, credit, and commodities, as well as in bonds. We call this the asset reflation trade. It relies on slowly fading uncertainty and central banks staying on hold for long, in the presence of no return on cash. It remains the main reason we are long
risky assets, while only trading bonds from the short side instead of being aggressively short duration.
• Many fundamental investors are uncomfortable with a rally driven by cheap money. We understand this unease, but still want to ride this rally, as it is stimulative policies that are required to get the economy going. We would prefer higher asset prices driven by a stronger economy, but accept that we will likely get the reverse –– a stronger economy driven by higher asset prices.
• What economic activity news we did receive this week was broadly consistent with our forecasts, again holding our 2010 global growth forecast on hold, even as we retain an upside risk bias for Q1. Japanese data were impressive, EM Asia was fine, while the US was mixed.
• More important news was confirmation of our economists’ long-standing forecast that core inflation in developed economies will fall below 1% this year and next. Euro area core inflation has fallen to a record low of 0.8% oya, and the US fell to the same rate over the past six month (only 1.3% over the past 12 months. Japan’s rate has fallen to a record low.
• Disinflation is good for risky markets to the extent that it keeps central banks near zero policy rates and depresses corporate costs, thus pushing up profit margins. But inflation falling below 1% is bad for risky assets to the extent it brings us to the verge of Japanese-style deflation. The fact that consensus forecasts on US profits have been rising steadily over the past year
The J.P. Morgan View
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