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Home > Investments > Economic Indicators

By Nick Reeve and Bradley Gerrard | Published Sep 17, 2012

Bond managers warn of added inflation risk after Fed’s QE3

Bond fund managers last week warned of a heightened risk of inflation, after the Federal Reserve last week pledged open-ended quantitative easing (QE) to boost the ailing US economy.

The US Federal Reserve launched a third round of quantitative easing – the central bank is to buy up to $40bn (£24.7bn) worth of mortgage-backed securities every month in an attempt to increase liquidity in the financial system.

Prompted by stubbornly high US unemployment, Fed chairman Ben Bernanke said the stimulus would continue until the US labour market improves. He also announced an extension until the end of 2012 of “Operation Twist”, which the Fed uses to swap shorter-dated government bonds for longer-dated bonds.

Chris Iggo, chief investment officer for fixed income at Axa Investment Managers, said he believed the US would experience a “strong” recovery in 2013 thanks to the QE3 package.

He said: “We know the corporate sector is sitting on unprecedented levels of cash because it needs confidence in the macroeconomic outlook. Central banks have now taken out tail risks, so there is potential for confidence to come back. We need to see hiring and investing in the corporate sector but I can see that happening and the monetary environment is very supportive.”

However, Old Mutual Asset Managers UK’s head of fixed income Stewart Cowley responded by selling a 25 per cent exposure to the dollar last week and bought euros in his £757.7m Global Strategic Bond fund, amid fears that QE3 may be “counterproductive”. As part of the trade Mr Cowley also reduced his fund’s duration, or sensitivity to interest rate rises, to 1.2 years.

“We put both an inflation and a deflation trade on earlier this year but the inflation trade is now winning and we are emphasising that,” he said. Mr Cowley said he also has a “punchy” 25 per cent weighting in inflation-linked bonds, which pay out coupons that rise if inflation goes up.

The manager added that balancing inflation, duration and currency risks would be increasingly challenging going forward – and that many top managers may get “wrong-footed” by it.

Anthony Doyle, investment specialist at M&G Investments and one of the company’s Bond Vigilante bloggers, agreed that US QE could increase the risks of inflation, adding the package could continue “well into 2013”.

He added that M&G’s bond team was waiting for longer-term US government bond yields to reflect a higher risk of inflation rising, as more money floods into the economy. “We would now start looking for a smooth but steeper move higher for [longer-dated bond yields] to reflect a higher inflation risk and greater policy traction over time,” Mr Doyle said.

The action came after the European Central Bank launched its own bond-buying scheme – known as Outright Monetary Transactions (OMT) – to ease the eurozone crisis.

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