Where is that inflation? Central banks have this fixation on 2% inflation as both a goal and a signal. Policies have been structured for the magic 2% and signals for balance sheet action are based on the inflation hitting 2%, yet current inflation has not been able to reach this number. Growth expectations have been moved higher, yet there seems to be continued economic slack that will not allow product prices to push beyond 2%. Hence, central banks have held to current policies. (An exception was the Bank of Canada this month.) The result has been further asset price appreciation and more leverage. This combination will have to be adjusted, but not today. Nevertheless, markets are still hyper-sensitive to monetary policy musings.
High valuations and leverage make for a more difficult environment when there is a more market uncertainty concerning geopolitical shocks. As noted in a recent post, (AllianzGI Risk Monitor survey – Geopolitical risk on the rise, requires special thinking), geopolitical risks is on the rise as the top risk with investors. These types of risks are especially difficult to hedge given the impact across many asset classes. Growth expectations can be reversed quickly on a negative geopolitical event and leverage will make economies more sensitive to any shock. Investors have to think about strategies that will be more nimble to a negative geopolitical shock.