(Bloomberg) — Parts of bond markets around the world have started to signal that inflation risks will linger in the longer term, even as few expect prices to jump right away.
Unprecedented stimulus to cushion the global economy from the pandemic and signs that central bank independence is eroding worldwide have kept inflation concerns alive. That’s showing up as one factor in credit markets, where longer-dated bonds that are more sensitive to inflation expectations have lagged in recent months, reversing earlier outperformance.
In the U.S., investment-grade corporate notes due in more than 10 years underperformed short bonds last month after posting the most losses among all maturities in August, according to Bloomberg Barclays indexes. And in the options market, the cost to hedge against inflation rising over 2% in the next five years has more than doubled since February. In Asia, dollar-denominated company securities with over 10 years to maturity were the worst-performing group for the two months through September.
Read about study that found signs of eroding central bank independence
That’s even though the sustained economic recovery that was going to usher in a new age of rising prices no longer looks like a sure thing as the pandemic drags on. Some popular trades betting on inflation that had done well over the summer have started to come undone, with growth stocks dropping and gold’s rally faltering. But for credit investors looking further along the horizon, a growing group sees eventual economic recovery gradually rekindling price increases.
“We think the worst of prices declines are over — some of the coronavirus shock-related disruption now has eased as economies start to reopen,” said Sylvia Sheng, global multi-asset strategist at JPMorgan Asset Management, who expects a risk of high inflation in the next three to five years driven by fiscal and monetary stimulus. “We prefer U.S. inflation-protected Treasuries over nominal bonds.”
BlackRock expects inflation to accelerate in the medium term as global production costs rise, the Federal Reserve allows overshoots in price increases, and political pressure to keep rates low intensifies. The U.S. consumer price index will rise by an average of 2.5% to 3% from 2025 to 2030, according to a note published last month.
The U.S. central bank and many monetary authorities around the world are determined to push inflation up from levels they consider dangerously low. Read more about that here.
Some market-based measures of inflation expectations remain elevated, with the so-called break-even rate derived from 10-year Treasuries near a 13-month high reached at the end of August.
In Asia, India this week reported quicker-than-expected inflation for September. On Wednesday, South Korea’s central bank left its key interest rate unchanged amid signs that a resurgence of the coronavirus at home is waning, and inflation is picking up.
Invesco’s head of Asia-Pacific fixed income, Freddy Wong, who is watching for longer-term impact on inflation from a shift away from globalization and an aggressive policy response to the pandemic, said his firm has been focusing more on profiting from shorter bonds rather than holding long debt.
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