European Central Bank President Christine Lagarde said at her press conference on Jan. 21 that “underlying price pressures are expected to remain subdued owing to weak demand, notably in the tourism and travel-related sectors, as well as to low wage pressures and the appreciation of the euro exchange rate.”
PHOTO: HOLLIE ADAMS/BLOOMBERG NEWS
Hefty stimulus from central banks combined with generous public spending programs aimed at helping major developed countries recover from the pandemic could result in a jump in inflation, causing headaches for fixed-income investors.
The message from central banks that interest rates will stay low for a prolonged period should keep short-dated bond yields pinned at low levels, but expectations for firmer growth and higher inflation may lift longer-dated yields, concerning holders of longer-dated debt.
“Inflation rebound is the main risk to bond markets near term (justified or not), which raises the question how do central banks/European Central Bank and markets react when inflation comes,” said Piet Haines Christiansen, chief strategist for ECB and fixed income research at Danske Bank.
Recent data show inflation has rebounded in the eurozone and the U.S., driven by the removal of deflationary pressures from the coronavirus pandemic from annual inflation measures.
In the eurozone, headline annual consumer prices rose by 0.9% in January, following five straight months of deflation, while annual core inflation reached a five-year high of 1.4%, up from 0.2% in December. In the U.S., annual headline inflation rate increased to 1.4% in December, from 1.2% in November.
“Maybe later in the year, depending how the economic recovery evolves, growth and inflation expectations are likely to have more of an impact, particularly on the U.S. side,” Henrietta Pacquement, senior portfolio manager and head of investment grade at Wells Fargo Asset Management, told Dow Jones Newswires recently.
Wells Fargo Asset Management expects the outlook for growth and inflation could replace the influence of central bank stimulus and the pandemic as the key driver of government bonds.
Many economists consider the recent rise in inflation to be temporary, however, which may allow bond investors to look through this trend.
Economists and asset managers say that inflation figures are affected by major statistical distortions, including the reversal of Germany’s VAT cut, store closures forcing potentially false estimates of prices, delayed winter sales, higher energy prices, and changes in the harmonized index of consumer prices (HICP) basket to reflect new spending patterns.
Technical factors were a well-flagged source of uncertainty and they should be ignored, said Frederik Ducrozet, strategist at Pictet Wealth Management. The rebound in core inflation is likely to be short-lived and should drop back once these technical effects fade, he said.
Nicola Mai, portfolio manager and sovereign credit analyst at Pimco, forecasts that the special effects distorting January’s inflation reading will reverse through the course of the year and “true” core inflation could be in the order of 0.5%.
Emily Roland, co-chief investment strategist at John Hancock Investment Management expects any rise in U.S. inflation to be limited, preventing U.S. Treasury yields from rising significantly. A recovery in China and a weaker dollar are helping to push U.S. inflation higher, but large slack in the labor market and an elevated savings rates are disinflationary, she said.
“There are a number of factors that are temporarily pushing inflation higher right now, but ultimately there are also a lot of factors that are pushing inflation lower,” Roland said recently to Dow Jones Newswires.
Others argue that economies being able to reopen should cause a jump in growth and inflation, but this won’t necessarily mark the start of a new inflationary trend.
European Central Bank President Christine Lagarde said at her press conference after the central bank’s Jan. 21 monetary policy meeting that “underlying price pressures are expected to remain subdued owing to weak demand, notably in the tourism and travel-related sectors, as well as to low wage pressures and the appreciation of the euro exchange rate.”
Then, once the impact of the pandemic fades, a recovery in demand, supported by accommodative fiscal and monetary policies, will put upward pressure on inflation over the medium term, Ms. Lagarde said.
Ariel Bezalel, fixed income strategist at Jupiter Asset Management told Dow Jones Newswires that once this happens, growth and inflation momentum should fade after one or two quarters.
“Deflationary pressures are still the dominant forces rather than inflationary ones,” Mr. Bezalel said.
Write to Maria Martinez at maria.martinez@wsj.com and Emese Bartha at emese.bartha@wsj.com