Is inflation on the horizon?

Jim Leaviss – lead manager of the M&G Global Macro Bond Fund

"There are powerful forces which have been keeping inflation low for decades like globalisation, ageing populations and technology. So you’ve got to be confident that something is very different in the global economy before getting too worried about inflation. That said, something has changed.

The world’s seen record stimulus, and it’s far more concerted than in previous cycles. This time really is different. Governments and central banks are pursuing expansionary policies together more blatantly than ever. So it’s likely we can expect a fairly significant rebound in demand in 2021 given that many households are in a reasonably strong financial position (though many are not) with pent up demand.

In the shorter term, there will also be some base effects from low commodity prices in 2020 and shipping container shortages. Looking ahead, the US minimum wage and rising global food prices are inflationary too.

If inflation picks up, I think central banks will be far more hesitant in tightening financial conditions than we’re used to. The Federal Reserve (Fed) have moved from targeting 2% inflation to targeting a long-run average, giving them freedom to allow inflation to run a little higher after a period of lower inflation.

And, with government debt at near record levels, there’s a clear incentive to keep short-term rates anchored down."

How are you investing the M&G Global Macro Bond fund?

"As a flexible global bond strategy the fund is well equipped to navigate the longer-term challenges facing the global economy. It isn’t benchmark-constrained and can invest where we see the best value across developed markets, higher-risk emerging markets and currencies.

This flexibility has allowed us to position the fund tactically for an expected reflation scenario in 2021 as the global economy re-opens. Around one quarter of the fund is held in a variety of global inflation-linked bonds, including a significant allocation to US Treasury Inflation Protected Securities (TIPS). A sharp increase in inflation expectations since the start of 2021 has driven a strong outperformance of TIPS versus conventional US Treasuries, although we believe these instruments continue to provide inexpensive insurance against the risk of higher inflation.

A distinctive feature of the fund is its ability to invest in currencies, not only as an additional way to generate returns, but also to diversify risks. We’ve made use of this to gain exposure to currencies that tend to be positively correlated to inflation or commodities such as the Australian dollar, Norwegian krone and Canadian dollar.

While rising inflation is normally seen as negative for bonds, there are a number of fixed income instruments which can help to offset the negative impact of inflation. While the longer-term outlook for inflation remains unclear, we believe flexibility will remain paramount in a changing world."

Ariel Bezalel – manager of Jupiter Strategic Bond Fund

"The inflation debate has dominated this year as the global economy has sprung back to life. Many disagree with the Fed that the higher rates of inflation are transitory. Some think prices will remain sticky and believe we’ve entered a new paradigm whereby inflation will move higher in coming months and years as the authorities have overcooked it with the stimulus implemented in the last year or so.

I believe inflation is likely to come in on the high side for a while yet as supply chains are challenged. However, as we go into September and beyond, and supply chains are restored and bottlenecks are eased, inflation should start to retreat. When prices are distorted to the upside, in a free market economy there’s typically a supply response. Domestic businesses that have benefitted and gained market share, as importers have been effectively locked out, will once again face competition as borders are reopened and may cut prices to retain market share.

A lot of the surge in the inflation numbers of late has been driven by Covid impacted sectors, such as used car prices, restaurants, hotels and airlines. As the economy gradually normalises, prices should revert to more normal levels. And as we head into 2022 and the fiscal stimulus fades, the disinflationary environment that dominated pre-Covid is likely to come back. Too much debt and aging demographics are likely to constrain growth once again.

We’re beginning to see signs of a slowdown in China with the flow of credit starting to dry up. This has negative implications for global growth and commodities. Additionally, tough negotiations in Washington around an infrastructure bill have highlighted that Biden doesn’t have carte blanche on fiscal policy, as many of the inflationists were led to believe."

How are you investing the Jupiter Strategic Bond fund?

"Having a decent allocation to high quality AAA rated sovereigns makes sense considering it’s likely that growth will disappoint, and interest rates will remain lower for longer. It acts as a good ballast to the portfolio in times of trouble. With growth ticking along and default rates likely to remain extremely low for some time, we think high yield should do fine. Returns won’t be what they were last year, but they should give a decent pickup in return over cash.

However, considering the tightness of credit spreads, bond selection is key and that’s where having an experienced team of credit analysts comes in handy. Having a flexible mandate where we can seek out ideas across the globe also helps. We think investment grade is fully priced and have exited much of our exposure here. Emerging markets is a place where one has to be very selective as Covid continues to ravage many economies and many places are reliant on Chinese growth.

Given the slowdown in their growth, one of our top picks is Chinese government bonds where yields are higher than in the west. China’s gradually starting to suffer from the issues that have haunted us for many years. Namely, too much debt and poor demographics as population growth grinds to a halt. Therefore, over time, bond yields are likely to converge with yields in the west."