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Felix Wintle
Fund Manager
One of the most asked investor questions these days is: 'Is this bout of inflation sustainable or is it a flash in the pan? And therefore, is this run-up in bond yields a temporary phenomenon or the start of a new trend?'
It’s a key question, arguably the most important question in macro right now, and clearly has big consequences for asset allocators and investors alike. Rising bond yields, it’s sometimes said, are bad for equity prices, but this is not true. They can be bad for certain sectors and factor styles, as we’ve seen recently in Tech and Momentum stocks, but conversely can be good for other sectors like Energy and Materials. So getting the direction of the ten-year bond yield right is critical, and understanding where inflation is going is a big part of that equation.
When looking at inflation, it’s important to remember its cyclicality ie: it changes a lot over time. So I am not that interested in trying to ascertain whether inflation will be higher or lower in a year’s time, because that time frame is too long, there could be many ups and downs over one year. I have always focused on the near term outlook for inflation in the tactical half of my portfolio because that’s what we as investors have to deal with now; what’s going to happen in the next few months is the reality we have to navigate and that should be our focus. So, what is the near term outlook for inflation?
Inflation is about to spike higher. We can be so confident of this because of the year on year base effects. March will be the first month of comparisons to the Covid crash era and this makes the comparisons the easiest in living memory and, in some cases, the easiest in history. Consider the oil price:
One of the most interesting features of this post-recession recovery period is the degree to which consumers are emerging in such good shape. This is the only post-recession period in history where consumers have emerged better off than when they went in. Consumers’ enormous purchasing power can be seen in the chart below:
This chart shows that once you add up all the stimulus and the hand outs, there is an extra $1tr in consumers’ pockets. Retail sales are already coming in hot and we expect this to continue as another $1.9tr of stimulus, much of it aimed directly at consumers, has just been approved by Congress.
And what’s the position of the Fed and the Government in light of all this free money and inflationary pressure? More stimulus and low interest rates. Fed Chair Jay Powell said in June 2020 “We’re not even thinking about thinking about raising interest rates”. Bond yields have gone straight up since then and shows that the Federal Reserve is behind the curve on inflation and happy to ‘let it run hot’.
In summary, I believe that inflation is going to spike over the next few months and that bond yields will go higher. At the time of writing the ten year bond yield sits at 1.58%, I wouldn’t be surprised if that is at 2% in a few weeks. That would only take us back to pre Covid levels, and with all the pent up demand coming as the economy re-opens that could just be the start.
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