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Summit News

What inflation? Investors seek protection as price rises beckon

NEW YORK/LONDON (Reuters) - Investors are buying assets to protect their portfolios from a potential rise in inflation, even though many are not forecasting a dramatic surge in consumer prices.

FILE PHOTO: The Charging Bull or Wall Street Bull is pictured in the Manhattan borough of New York City, New York, U.S., January 16, 2019. REUTERS/Carlo Allegri

Measures of inflation expectations, while still below the U.S. Federal Reserve’s target, have risen in recent days to 18-month highs on revitalized hopes of more stimulus to help the U.S. economy fight the fallout from COVID-19.

The yield on the U.S. 30-year Treasury bond , which is sensitive to inflation expectations, recently stood at 1.749%, approaching levels last seen in June.

Investors at the Reuters Global Investment Outlook Summit said they are favoring Treasury Inflation-Protected Securities (TIPS) and commodities, whose prices rise with inflation.

“It is worth considering more inflation protection in portfolios now,” said Jim Leaviss, chief investment officer for public fixed income at M&G Investments in London.

“The unwinding of the disastrous economic performance of 2020 will help to some degree” in boosting inflation, said Leaviss, although it was not clear whether it would be a one-off increase or permanent.

The 5-year and 10-year breakeven inflation rates closed on Thursday at their highest since May 2019, and the 30-year closed on Wednesday at its highest since April 2019. The 5-year breakeven was last at 1.829% and the 10-year at 1.904%. The 30-year rose to 1.995% - just under the Fed’s 2% target.

Rick Rieder, BlackRock’s chief investment officer of global fixed income, said he likes TIPS in case of a moderate rise in inflation, but is not expecting a surge in prices.

“You hear some crazy stories about how inflation is going to burst higher but it’s just not. People don’t pay more for goods because money supply is higher,” Rieder said. “If the price of food and energy and apparel and transportation is lower, then they pay down their debt.”

U.S. inflation has in the last decade consistently averaged well below the 2% target set by the Fed, with the Personal Consumption Expenditures price index (PCE) - the Fed’s preferred measure of inflation - at 1.2% in October.

Trillions of dollars in government spending to offset the COVID-19 pandemic, however, have revived discussions of inflation’s return. The move in breakevens to 18-month highs has been spurred by renewed hopes that Congress could pass a fresh stimulus package.

Investors who believe fiscal stimulus will bolster growth and inflation are entering the so-called reflation trade, which involves the addition of TIPS and other inflation-protected securities to a portfolio, as well as bets on higher stocks, higher Treasury yields and a weaker dollar.

Citigroup’s Scott Chronert said in a research note on Tuesday that an early sign of a reflation rotation could possibly be seen in ETF flows last month, which showed stronger moves into U.S. equities versus fixed income.

PIMCO Chief Investment Officer Dan Ivascyn sees inflation trending higher in 2021, approaching 2%, but does not believe it will become a meaningful problem in the next few years.

“We do like areas of the market that can benefit from ongoing reflation. So we remain fairly constructive on commodities,” he said.

Ivascyn said other inflation-protected fixed income areas of the market with relatively low breakeven rates “look mildly to moderately attractive. We think clients should think about inflation protection.”

The iShares TIPS Bond ETF rose this week to its highest since late September. The SPDR Portfolio TIPS ETF on Monday reached its highest since mid-October. This week has seen the second largest weekly inflow ever into TIPS - approximately $2 billion - according to Bank of America.

Inflation expectations in Europe have also pushed higher in recent days, a good sign for the European Central Bank, which has undershot its near 2% inflation target for more than seven years.

Euro zone inflation in November, however, fell for a fourth straight month year-on-year.

Still, some investors were more concerned about a run-up in prices.

Pascal Blanqué, chief investment officer at asset manager Amundi, said the world was entering a new macroeconomic regime and that stagflation - a period of poor economic growth and high inflation, as seen during the 1970s - beckoned.

“Many people think we are in the 1930s... I think we will wake up somewhere in the 1970s,” he said. “The consequences for financial stability are being challenged. All in all we are transitioning toward a regime shift in the macro financial world.”

Reporting by Sujata Rao and Dhara Ranasinghe in London, Kate Duguid and Megan Davies in New York; Writing by Megan Davies; Editing by Dan Grebler

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