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Is inflation on the horizon?

We asked two expert bond fund managers for their views on inflation and how they're investing.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

All information is correct as at 30 June 2021 unless otherwise stated.

Inflation’s a measure of how much prices have gone up over time. It’s the rate cash becomes less valuable – £1 this year will get you further than £1 next year.

In recent years inflation has been low. But after the huge spending packages from governments and central banks around the world to help stimulate their economies, some think it could be on its way back. Recent inflation data from the US Labour department showed inflation rose 5% in the year to May. A sign of an economy gathering pace.

If inflation’s too high or volatile, it’s hard for businesses to set the right prices and for people to plan their spending. But if inflation’s too low, or even negative, then some people might put off spending because they expect prices to fall.

Inflation can be good for stock markets – it normally means the economy is growing, but too much of it can also be an investor’s nemesis. If it gets too high and interest rates rise, it would affect the discount rate used in many valuation calculations. The lower the discount rate, the more future cash flows are worth and the higher the value the investment has today. When inflation’s low, the value of future bond payments isn’t eroded as much.

We asked two bond experts for their views on inflation. They both manage their funds flexibly, taking into account wider market and economic conditions, including inflation. We also asked them how they’re investing their funds given their views.

This article isn’t personal advice. Investments can fall as well as rise in value, so you could get back less than you put in. If you’re not sure if an investment is right for you, ask for financial advice.

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."

What do we think all this means for investors?

Investors should pay attention to the forward guidance issued by central banks. Things can change quickly and as such, we think it’s valuable to invest with talented managers running flexible funds. If certain risks, like higher inflation, increase or if new opportunities crop up, they can quickly change how their funds’ invested.

Recently the Bank of England’s Monetary Policy Committee said it expected the UK’s (consumer price) inflation to go above 3% “for a temporary period”. The rate hit a two year high of 2.1% in the year to May. The takeaway message here, much like the one in the US from the Fed, is this will be temporary. The time to apply the brakes and hike rates isn’t now.

Whatever you think will happen to inflation and any subsequent knock on effects, it’s important to build a well-diversified portfolio. This should include different types of investments, ranging across different sectors and parts of the world. Investing in funds can be an easy way to diversify. That way you can invest with managers who have different approaches and investing styles.

Researching investments, including funds, can be a time-consuming process. To make investing in funds easier, we have our Wealth Shortlist of funds. These funds have been chosen by our analysts for their long-term performance potential and to help build a well-diversified portfolio.

The Wealth Shortlist is designed for investors comfortable in picking their own investments. Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

Find out more about our Wealth Shortlist.


Explore our Investment Times summer 2021 edition for more articles like this.

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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