Inflation & Rates in focus

Inflation risk and rates volatility at the forefront…

In 2021, inflation expectations rose on the back of economic re-starts, rising production costs as supply chains are re-wired globally combined with continued monetary and fiscal policy stimulus. BlackRock’s Investment Institute (BII) expects higher inflation to have different implications than in the past, as central banks keep policy rates low. Q1 saw a sharp rise in 10Y US nominal rates, initially driven by inflation expectations and later real rate rises as markets demanded a higher premium for government bonds. Since then in Q2 and Q3, nominal yields have fallen, with inflation expectations stabilising and real rates continuing to decline. However, the Federal Reserve’s (Fed’s) confirmation of tapering makes it likely that if their base case plays out, developed market bond yields bottomed at the beginning of August, with a gentle rise on the horizon. With inflation pressure here to stay for the medium term while low yields offer reduced ballast in portfolios, BII is strategically and tactically overweight inflation linkers while being underweight nominal government bonds. Shorter-maturity, interest-rate hedged or floating rate exposures may suit investors looking to limit (nominal) duration risk. (Read BII’s full 2021 Market Outlook) Indeed, investor flows into UCITS FI ETFs so far this year have shown a clear preference for shorter duration exposures and inflation linkers over longer-duration and nominal government bond exposures.