Bond veteran Greg Wilensky has seen the hype about an inflation attempt break too often to get swept up in this year’s big reflation trade.
“I have been managing bond portfolios for 25 years through very large monetary programs, large deficits and the Fed trying to raise inflation expectations,” Janus Henderson’s money manager said in an interview. “As much as I can see legitimate reasons why it could happen this time – I could have said that many times over the past 12 years.”
Wilensky’s skepticism epitomizes the cooling investors’ enthusiasm for bets linked to a rapid economic recovery and higher prices. Trade bias towards economically sensitive value stocks, steeper yield curves and a recovery of first fifteen minutes.
The MSCI AC World Value Index has lagged about 6 percentage points behind its growth counterpart since March 8. Government bond yields have already fallen by about 13 basis points this quarter, even as US inflation rates are starting to decline. exceed expectations. And Tuesday strong 30-year Treasury auction suggested that even the most interest-exposed bonds are return.
One of the biggest questions facing money managers now is whether the stimulus-driven recovery in growth and inflation – particularly in the US – can transition to sustained expansion that will continue to drive stocks and bond yields. The International Monetary Fund recently has upgraded its global growth forecast for 2021 to the strongest in four decades, but the outlook beyond that is less clear.
It is even more difficult for investors to envision a trajectory for price levels beyond this year, given the warping effect of the coronavirus shutdowns, temporary supply bottlenecks and base effects of last year’s disinflation. A rise in five-year US breakevens – a gauge of inflation expectations – has slowed since they hit their highs since 2008 in mid-March.
Simple math is about to cause an inflation problem: QuickTake
“Inflation and interest rates, especially as a bond investor right now, is the call to make,” said Elaine Stokes, fixed income portfolio manager at Loomis Sayles. “It’s the make-or-break call of your year.”
The response to the freeze for many investors has been to cut back a number of deals targeting the sharpest phase of the economic recovery. Vishal Khanduja, a fixed income fund manager at Eaton Vance Management, has halved its portfolio overweight in US inflation-linked bonds since the beginning of the year.
“Inflation expectations were dislocated in 2020” in a “surgical recession,” said Khanduja. “The typical post-recession positioning that you see happening over several years is rapidly moving through the market.”
The Franklin Templeton Arabian Gulf bond fund has has removed its hedges against the risk of accelerated US inflation as it sees a new spike in government bond yields as “possible, not likely,” said the Dubai-based manager.
As for some traditional inflation hedges in commodity markets, the story is about to get more complicated than the year-to-date recovery in oil and copper prices suggests. The strategists at the BlackRock Investment Institute expect a divergence within the asset class, as factors such as climate risks are better factored into pricing.
“The boom for oil from the economic reboot is likely to be transitory, while some metals could benefit from structural trends such as the ‘green’ transition for years to come,” a team including Wei Li wrote in a note this week.
Huge challenge
Meanwhile, bond market traders are not responding to signs of inflation as one might expect. On Tuesday, the data showed US consumer prices rose the most in nearly nine years in March, but 10-year Treasury yields fell five basis points to its lowest level in three weeks.
“The huge challenge at the moment, especially this year, is that the quality of almost all the data that we look at, whether it be the short-term inflation data, the economic growth data, these things are very much distorted by the volatility, ”Wilensky said of Janus Henderson.
– With the help of Netty Idayu Ismail and Sid Verma
Adds Franklin Templeton’s move in the 10th paragraph