Kames warns of inflation challenge

The world faces a headline inflation problem unless the price of crude oil remains below $50 a barrel, says David Roberts, head of fixed income at Kames Capital.

Current central bank policies, particularly in the US and the Eurozone, are liable to stoke inflation to problem levels at a time when core government bonds are trading at completely irrational valuations.

Rates markets tell us all is broken, but the fact is the state of the world isn’t as bad as it is currently made out to be. In fact, I’d rather see US Federal Reserve chair Janet Yellen raise rates and push the dollar up a little.

However, in the same way the Fed had an opportunity to start raising rates in 2014 but failed to do so, I think we will be disappointed again; central banks won’t take the plunge.

US GDP grew 1.4% in the fourth quarter of 2015, faster than the previously estimated 1%, while core inflation hit 2.3%, with headline inflation at 1.0%.

In the medium term,  no further Fed action and more ECB quantitative easing are sub-optimal, although they will support risk assets a while longer – at a price. Unless oil stays below $50 a barrel, we will find ourselves with a headline inflation problem. Of course G7 markets have ignored that fact for nearly a decade, leaving many to buy core government debt at completely irrational valuations. I am happy not to be one of them.

The £605m Kames Strategic Bond Fund, remains modestly short duration relative to its peers in February. But we may pare duration to the bone if some G7 yields move further into negative territory.

I very much dislike G7 bond markets, especially core European and UK sovereign markets, at current value levels. However, my experience over the past two years has taught me that fighting European Central Bank (ECB) President Mario Draghi and the madness of negative yields is more often than not a battle I will lose.

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