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Inflation expectations: People walk past a Barclays branch in London. Together with HSBC, the lender says mounting concern over the Fed’s slow response to inflation is driving investors toward bonds that offer protection against rising prices. — Bloomberg
NEW YORK: Barclays Plc and HSBC Holdings Plc say concern the US Federal Reserve (Fed) is dragging its feet on inflation is giving investors another reason to buy bonds that offer protection from accelerating price growth.
Long-maturity US yields hit their highest in almost two decades last week as Fed chairman Kevin Warsh’s refusal to say how policy makers will control inflation fuelled worries the central bank may act too late, even though he’s been adamant about keeping a lid on price growth.
That came on top of wild swings in oil markets and concerns about government spending.
At the same time, breakeven rates, which measure inflation expectations, are close to their lowest in a year.
“I’d expect the market to price greater inflation risk into the curve, following what’s been interpreted by the market as a ‘dovish hold’ with questionable credibility,” Jon Hill, head of US inflation market strategy at Barclays.
“That would mean wider breakevens, and inflation-linked bonds outperforming conventional ones.”
After the Fed meeting, HSBC’s Dhiraj Narula reiterated a recommendation on long-maturity US bonds that protect against price growth, citing concern about the US central bank’s “longer-run commitment to inflation control”.
While a Bloomberg gauge tracking inflation-linked debt is up 0.3% this year that’s still a better showing than the 0.7% loss for an index of conventional sovereigns in the period.
Inflation-linked bonds shield investors by paying a yield that’s adjusted higher to account for the inflation rate.
The so-called real yield, which doesn’t include that adjustment, is currently at 2.93% for 30-year US Treasury Inflation Protected Securities, having peaked at 3.04% last Friday, the highest since 2008.
“We still view inflation-linked bonds as offering value at current real yields,” said Jorge Garayo from Societe Generale SA.
The chances of a comprehensive Middle East peace are “highly unlikely”, he said, and low inflation breakevens showed the market is “complacent” about the possibility of higher energy prices feeding through into prices and wages.
Elsewhere, Kevin Kidney has boosted True Potential Investments LLC’s inflation-linked sovereign holdings to about 20% of the firm’s flagship multi-asset fund range.
He worries central banks, and the Fed, in particular, are happy to accept a faster pace of price growth.
“We believe that central banks are willing to accommodate a higher level of inflation than they communicate,” Kidney said.
Stefan Koopman, senior macro strategist at Rabobank puts it another way: “The investment case for inflation-linked bonds is not simply that inflation stays above 2%,” he said. “Rather, it’s that 2% may increasingly act as a floor rather than a ceiling.” — Bloomberg
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