Partner Content by Artemis

Target return: Generating real returns from bonds in a time of inflation

Capital at risk. All financial investments involve taking risk, which means investors may not get back the amount initially invested. 

 This advertorial will cover the following points:

  • Tighter monetary policy and reduced fiscal stimulus will be offset by private-sector demand.
  • Benign economic growth should support credit markets, particularly high yield.
  • Long-dated government bonds are particularly exposed to a removal of liquidity by central banks and the end of quantitive easing.

The economic environment

The outlook for inflation remains an open-ended question

Prices will rise further over the coming months. The market suggests that RPI in the UK will hit 7.4 per cent in April-May. So irrespective of the long-term outlook, uncertainty about inflation will remain a live question.

Longer term, the transition towards a greener economy is likely to support inflation for years to come. Set against that, however, we are conscious that the disinflationary drivers (including demographics) that dominated the economy over the past few decades have not entirely disappeared.

On balance, our view is that the ‘landing zone’ for inflation will be higher than it has been over the past decade, during which the main concern was deflation. But we don’t think inflation is likely to become overly problematic. It is hard to foresee the world jumping directly from widespread ‘Japanification’ before Covid-19 to the sort of prolonged, high inflation we saw in the 1970s. A landing point somewhere in between seems likely.

We fundamentally disagree with worries about ‘stagflation’

The peak of inflation – not yet reached in many economies – is so high that it will require some time to fall back towards target. At the same time, all the signs are that economic growth is likely to remain healthy: so this is not ‘stagflation’.

Private sector demand will support growth

The biggest brake on growth will come from fiscal policy. Although most economies will continue running a meaningful fiscal deficit through 2022, the fiscal impulse will turn negative. But we believe this will be more than offset by the fundamental strength of the private sector.

In the corporate sector, the inventory cycle will be supportive: current stock levels are inadequate, particularly in the manufacturing sector. Investment will also increase – with automation likely to be a focus should wage pressures persist. In Europe, meanwhile, the Next Generation EU funds will continue to be distributed, supporting demand.

Restocking required: Inventory levels are extremely low

 Bloomberg, NFIB small business survey 30 September 2021

Consumers are in a strong position going into 2022

Pandemic-related restrictions on spending saw households increasing their savings and paying down debts. It is well known that excess savings have increased; what it is less discussed is that these savings (amounting to almost $4tn [£2.9tn] in the US) are largely sitting in cash and so can be rapidly deployed.

The strength of consumers’ financial position results from more than just savings: jobs are being created and wages are rising.

Household savings rate

 Bloomberg as at 30 June 2021

Rising wages, especially for low-skilled jobs, should also support spending

In contrast to the period that followed the global financial crisis, wages for low-income workers have been increasing more rapidly than those for high-skilled jobs. This matters for aggregate demand: low-income workers tend to have a much higher propensity to spend.