At the start of 2017, the US economy had reached a key juncture. There was an opportunity for the central bank-driven reflation of 2016 to morph into a self-sustaining economic recovery with business and consumer spending creating a virtuous circle of positive contributors to growth and inflation. 
In our view, president Donald Trump’s fiscal plans represented a crucial trigger mechanism to convert soaring corporate and consumer confidence into materially higher spending.
Unfortunately, he has presided over one of the most dysfunctional and ineffective administrations in recent memory, marked by a failure to achieve any significant legislative accomplishments. Private sector spending has consequently failed to inflect sharply upwards as we had hoped.
Without a hand-off from central banks to more sustainable sources of economic growth, we see increasing risks that the 2016-17 rebound will be another false dawn for the US economy. In the first half of 2017, economic growth failed to pick up materially while inflation was disappointingly low.
The Federal Reserve now faces a dilemma. It has set out a path of steady monetary policy tightening that appears initially justified by the low unemployment rate and a reasonable level of economic growth. We believe the conditions remain in place for steady economic growth in the second half of the year.
However, policymakers must now be alarmed that inflation remains below their 2 per cent target level despite a very loose monetary policy. In particular, wage growth has failed to pick up meaningfully despite the low level of unemployment and we believe this may reflect structural factors including globalisation and technological development.
We expect the sluggish level of US inflation to continue in the second half of 2017 and to contain the central bank’s ability to raise interest rates. We view this as a positive environment for government bonds and duration-sensitive assets.
It should also be a supportive backdrop for equities, which may be vulnerable to a correction in the short term but should ultimately benefit from continued central bank largesse. However, we have moved to a more balanced style exposure as value funds are less likely to outperform while government bonds rally. This has included introducing or adding positions in Legg Mason Japan and Polar Capital Biotechnology in the second quarter. We expect both to benefit from strong underlying growth, supported by long-term tailwinds from demographic change.
We also believe that emerging markets will increasingly follow a similar path to developed market central banks. They should benefit from a looser policy environment and a stable/weaker US dollar.
We have selectively increased our exposure to local currency bonds over recent months and also to equities. We believe the Waverton Southeast Asian Focus fund is well positioned for this environment and we have also increased our weighting in India, where we believe president Narendra Modi’s reforms represent a very exciting long-term opportunity.
Gold is another position that we have increased over recent months. In the recent past, it has been moderately positively correlated with government bonds and may benefit if yields fall as we expect.
More importantly, however, it also represents an attractive hedge against the unpredictability of president Trump, especially with a looming debate over the US debt ceiling in September.
Anthony McDonald is a senior investment analyst at City Financial Investment Company. All views are his own and should not be taken as investment advice.