Posted inFixed Income

Will 2017 be good for inflation-linked bonds?

US inflation in 2018 could reach nearly 3% if fiscal stimulus is taken into account, Jeremy Lawson, Standard Life Investments chief economist, said in a research note. The figure could be even higher if president-elect Donald Trump does follow through on campaign rhetoric to raise tariffs on Mexican and Chinese imports.

Other factors, such as tight labor markets, which generate upward wage pressure, decreasing rental vacancies leading to rental inflation, and rising healthcare costs, also give a supporting backdrop for inflation, Tim Foster, portfolio manager of the Fidelity Global Inflation Linked Bond Fund, said in a note.

Bond sell-off?

A major theme in 2017 will likely be a sell-off in bond markets, Jérôme Broustra, head of global rates of fixed income team at Axa Investment Managers, told FSA

“The secular bond rally in the past decade is coming to an end, and the performance in the fixed income markets is going to face a bumpy road,” he said.

“[In 2017] we believe we can have good and bad news successively – we will have some good news about growth forecasts and inflation, which favor higher yield. But at the same time we face an increasing risk of burdening debts,” which could be worsened by a rise in government spending and fiscal stimulus programs.

The inflation expectations in the US – the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity – have jumped 17 basis points last week to 1.87%, the highest since July last year.

Broustra believes the valuation for inflation-linked bonds in the US is still cheap and underpriced, while the expectations can go higher to at most 2.1% after supportive measures materialise in the future.

Fidelity’s Foster added: “If we do see trade agreements dismantled and economies turn protectionist, the impact on global growth will be negative. A slowdown in aggregate demand will weigh on activity and sentiment, but the expected commensurate rise in prices would make for a supportive environment for inflation-linked assets.”

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Inflation has been low. The three-year performance of Axa World Funds Global Inflation Bonds Fund and Fidelity Global Inflation Linked Bond Fund, in US dollar terms, both lagged the category average. However, some analysts believe inflation may start to accelerate.

 

Part of the Bonhill Group.