- Inflation expectations are falling but investors are nervous
- Central banks can pause if they believe inflation is under control
- Funds seek safety in TIPS, real estate, stocks and commodities
AMSTERDAM/LONDON, July 27 (Reuters) – Unconvinced by central banks’ promises to curb inflation, many investors are looking for assets that will protect their portfolios from years of monetary depreciation.
These funds buy inflation-linked bonds and real estate while taking long-term bets on the outperformance of stocks, including those in industries like timber and farmland.
“The new game in town is to preserve the purchasing power of the portfolio,” said Pascal Blanque, head of the investment institute at Amundi, Europe’s largest fund manager, referring to the hunt for assets that deliver returns that match inflation or surpass these.
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The resurgence of inflation after a long lull has surprised central bankers.
The Federal Reserve is likely to hike interest rates by another 0.75% on Wednesday to a range between 2.25% and 2.5%, the highest since 2019. Fed Chair Jerome Powell is expected to underscore the firm’s determination Bank reiterates bringing inflation back on target even if it means recession. Continue reading
Policy makers are on the right track if markets are to be believed. Market-based indicators of inflation are falling towards central bank targets and about 60 basis points have been saved from peak Fed interest rates for this cycle.
Long-term inflation expectations for the eurozone have also declined since May.
Nonetheless, many investors are bracing for an extended period of “fixed” inflation, somewhat comparable to the low-growth, rising-price era of the 1970s, and do not expect inflation to scale to what central banks are aiming for Level slowed down from 2%.
BofA’s latest monthly survey found that persistent inflation was the top fear among fund managers worth $800 billion.
NO NATIONAL
These fears are primarily driven by two factors.
First, central banks are confronted with the inflationary effects of tight commodity and labor markets and the rising costs of transitioning to a greener global economy, which conventional monetary policy is less able to counteract.
The other problem could be the central banks themselves.
With inflation more than four times target, it’s hard not to look back at Fed Chairman Paul Volcker, who raised interest rates to 20% in the 1980s, plunged the economy into a recession, but one double digit inflation killed.
Few believe central banks today can share Volcker’s anti-inflationary resolve or ignore the impact on economies, especially as current explosive debt levels make it difficult for borrowers to afford significantly higher interest rates.
“Inflation will be much more persistent than markets are pricing in…because the Fed won’t see through (the rate hikes),” said Alex Brazier, deputy chief of the BlackRock Investment Institute.
Brazier, a former member of the Bank of England’s fiscal policy committee, expects the Fed to hike rates to 3.5%, but a sharp slowdown in growth would prompt “a more nuanced response”.
The result will be inflation of more than 5% next year and over 3% in 2024, he predicts, well above the Fed’s median forecasts of 2.6% and 2.2% for the personal spending index.
This view underpins BlackRock’s longer-term recommendation for equities versus government bonds, with a firm ‘underweight’ to longer-dated debt as investors want more inflation compensation.
Jim Reid, head of global fundamental credit strategy at Deutsche Bank, reckons the Fed will halt raising rates before raising rates to the “restrictive” 5% range needed to cool inflation and leaves “inflationary deals unfinished”.
NO EASY MONEY
Regardless of how investors protect themselves from higher inflation, stubbornly high price growth will likely make it harder to generate returns than it was during the easy-money era of the last two decades, when inflation was low and predictable.
Chris Jeffery, head of rates and inflation strategy at Legal and General Investment Management, expects US core inflation to come in at 4% next year.
Aside from real estate, he is buying stocks exposed to timber and farmland, as well as government inflation-linked bonds (TIPS) following the recent drop in inflation expectations.
“You don’t have to complicate this too much. If you want to protect against inflation, TIPS are no longer incredibly expensive,” Jeffery said.
Some of the assets that performed strongly in the 1970s are shining this year.
According to a Deutsche Bank study, gold, silver and oil rose in the 1970s with average annual returns adjusted for inflation of about 20%, followed by real estate, aluminum, nickel, corn, soybeans and wheat.
BofA’s latest monthly survey showed that “long” trades in July were the second most popular trades in commodities and energy.
Deutsche Bank’s Reid said that the outperformance of stock and bond indices in recent years has been based on low and stable inflation, but such price stability no longer exists.
The Deutsche Bank study found real losses for the S&P 500 of about 1% per year up until the 1970s.
“If you think the era (of low inflation) is about to reverse, it’s very difficult to see financial assets doing well overall,” Reid added.
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Reporting by Yoruk Bahceli and Sujata Rao Editing by Tommy Reggiori Wilkes and Jane Merriman
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