Global economy ‘on a knife edge’

In its First Half Outlook for 2017, fixed income research house BondAdviser said fiscal policy promises by US President Donald Trump have shifted deflationary market expectations back into "normal" territory.

Investors have regained confidence that inflation could finally be returning to global markets that appeared to be mired in deflation, said the report.

But the execution of fiscal stimulus policies by the new US president will be crucial to maintaining market confidence, said BondAdviser.

"Our analysis suggests the biggest issue for these policies will be choices the [US] Federal Reserve makes in regard to raising interest rates in the face of an arguably larger debt obligation," said the report.

"As a general rule, central banks do not anticipate inflation (albeit market expectations are observed) but will wait until it actually emerges. Actual core inflation
(monthly) is only now in line with the Fed’s target average inflation rate of 2.00 per cent."

However, inflationary pressures will only persist if wage growth continues – something that is not guaranteed given the "structural headwinds" that technological advancements pose for the labour market.

"The global economy is poised on a knife-edge between inflation and deflation. The inflationary path could take hold, based on a combination of government spending (i.e. deficits) and low interest rates," said BondAdviser.

"Conversely, the deflationary pressures could prevail, based on fundamental factors such as a strong US dollar, deleveraging, technology and Fed tightening."

[Related: 'Trump effect' overblown amid sluggish growth]