Axa’s Jonathan Baltora sees ‘surprise inflation’ already in effect across world

Jonathan Baltora, fund manager of the AXA World Funds Universal Inflation Bonds, says in a comment that ‘surprise inflation’ has already taken hold in economies around the world.

Quantitative easing

Quantitative easing is actually working better than a lot of market players may think. We believe that the non-standard monetary policies implemented by the Federal Reserve are very efficient because the US dollar is the world’s reserve asset. Since the Fed has restarted QE, there is a lot of private borrowing in the US and this isn’t only US companies needs being fulfilled but also international corporates taking advantage of the very accommodative financing conditions. A significant share of that money is actually spent outside of the US thanks to the US dollar’s privileged status.

Negative real yields

Some investors have voiced concerns about negative real yields. It is true that this can be disturbing for fixed income investors but there is an easy way to explain this concept. The nominal yield for a sovereign can be broken down into real yield and inflation expectation. Real yields are correlated to nominal interest rates and turn negative when inflation expectations are higher than the nominal yield. In such a context nominal bonds will yield less than future inflation therefore this is a natural buy signal for inflation linked bonds.

Imported inflation from China

The Chinese growth model is evolving from ‘produce to export’ to ‘produce to consume’. This means that China needs a middle class and increasing wages. Wages have been increasing at between 15% and 20% a year while inflation has been hovering around 4%. Various institutions have estimated that the former Chinese export-led growth model has shaved 1% off the world’s inflation every year. This means that we should be ready for a least 1 more per cent of inflation.

On the UK inflation report

We should expect to see inflation forecasts consistent with the Bank of England inflation targets. Central banks in general do not acknowledge the new inflation regime and the stickiness of prices. Moreover the recent depreciation of the pound means that there is a clear upward inflation risk in the next 12 to 24 months.

The outlook for inflation

Finally we have estimated that in most advanced economies 1% to 2% more inflation will have a significant impact on the debt to GDP trajectory meaning that there is an incentive for Central Bankers to tolerate more inflation. Flexible inflation targeting means more inflation and also probably more volatile inflation, hence the need to be protected.

We do not expect Central Bankers to fix higher inflation targets as inflation only has a positive impact on debt to GDP ratios when it is a surprise. This is what is referred to as ‘financial repression’. Back in 2008, many economist were expecting inflation to be zero or even negative in many advanced economies. In 2012, not only headline, but also core inflation has been significantly positive across the world suggesting that the surprise inflation is already happening.

Is there value in inflation linked bonds?

Inflation break-evens trade below or at best at the last 10 year average inflation levels for maturities below 10 years. The shorter the maturities the lower the break-evens; this suggests that there is value in the asset class as we expect inflation to be running higher than past averages. We like 1 to 10 year maturities globally from a valuation perspective.


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