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Inflation expectations overtake decade high

Global investor expectations of inflation have surged to their highest level in more than a decade, according to a survey of money managers that underlines how Donald Trump’s election as US president has electrified financial markets.

More than 80 per cent of those surveyed this month by Bank of America Merrill Lynch believe that the global level of prices will rise over the next 12 months.

Although concern over inflationary pressures in the US had been rising before last week’s election, the president-elect’s pledge to turbocharge the economy with tax cuts and fiscal stimulus has strengthened the conviction that inflation will return for the first time since the financial crisis.

Anticipation of higher inflation has skewered the bond market, with the yield on the benchmark 10-year Treasury bond rising almost half a percentage point to 2.24 per cent since Mr Trump defeated Hillary Clinton and the Republican party retained control of Congress.

As a result of the changing outlook for inflation, two-thirds of investors believe that longer-dated bonds, a popular asset for much of the year, will now underperform.

In a further sign of the reverberations the US election has triggered in financial markets, the amount of cash held by global investors had its biggest monthly drop in November in seven years. Cash levels fell to 5.8 per cent from 5 per cent in October.

Although the biggest ructions have been in the sovereign bond market, the changing of the political guard in Washington has also produced sharp changes in the US stock market as investors rush into sectors more likely to benefit from a stronger US economy.

According to the survey of 177 institutional investors managing $456bn, 44 per cent predicted that this rotation would carry on well into next year, although just over a fifth believed the move would finish by the end of the year. Banks have been one of the big winners of the rotation out of the more defensive stocks that flourished in the first half of the year, with the S&P Banks index up 12 per cent in just over a week.

While reaction has been near euphoric in parts of the stock market, the survey, which was conducted in the five days after the US election, also showed some signs of nervousness that Mr Trump’s policy mix could generate inflation without much growth.

The biggest tail risk identified by investors was the fear of a “stagflationary bond crash”, with 23 per cent of those surveyed citing it as their biggest cause for concern.

Economists have pointed out that Mr Trump’s threat to impose tariffs on countries such as China and dismantle the free-trade zone covering the US, Mexico and Canada was likely to fan inflation.

And protectionist policies were cited as the biggest threat to financial stability, with 84 per cent of investors highlighting — the highest level since 2009.

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