SSGA-SPDR: The question of inflation

SSGA-SPDR: The question of inflation

Inflation
Inflatie (04)

The question of the moment, for investors, is inflation. Central banks’ rhetoric clearly suggests a view that the spike in CPI is the transitory impact of higher commodity prices and temporary distortions from impaired supply chains all acting on unfavourable base effects. However, market participants seem less convinced and appear unsettled by the apparent complacency of central bank officials.

While base effects will act to draw CPI lower during the second half of the year, there remain some pretty powerful forces acting in the opposite direction, not least the massive monetary and fiscal stimulus that continues to feed the demand side of the economy. Supply chains are not yet back to normal and, as a result, many surveys point to strongly rising prices.

The derived 1-year 1-year forward rate of US inflation has come off its highs, suggesting the market is a little more sanguine that recent upside surprises have run their course. However, the implied rate remains around 2.5%, which is in the range seen prior to the 2008 financial crisis rather than the post-crisis norm.

If inflation does prove more persistent than is widely believed, then there could be another leg higher for US yields. Indeed, European yields have also been rising, playing catch-up to their US counterparts as the better economic news gets priced into its bond market.

The coming few months will hopefully see the clouds surrounding the inflation outlook clear. Until there is more certainty that inflation will indeed revert to levels more consistent with what central banks view as sustainable, upside yield risks exist for fixed income markets.

With this in mind, remaining short duration should provide a degree of protection to investors, with returns coming from yielding strategies such as high yield and EM debt. This approach entails credit risks but the global backdrop of strong growth, which could spread to EMs as vaccination rates rise, should act as a stabiliser.