As Europe and the US become overburdened by debt and growth remains low, deflation rather than inflation would become the major pre-occupation for central bankers, according to JP Morgan AM’s international CIO for global fixed income Nick Gartside, who said fixed income would perform well in this environment.
“Government bonds should perform well,” he said. “The major competitor to governments are cash rates – going nowhere anytime soon and inflation – where the risks are tilted towards the downside as commodity prices fall.”
He pointed to 2008 as “a good guide” when in July oil peaked at $160 per barrel, falling to $60 per barrel by year end with dramatic consequences for inflation.
“Likewise, any bond that has a significant element of interest rate risk – investment grade credit, covered bonds, etc – should participate in this rally,” Gartside said. “Conversely, inflation-linked bonds, with breakeven inflation rates at elevated levels, look vulnerable.”
In the current climate, he said bond investors have two enemies: high interest rates and higher inflation. However, both are unlikely to present much of a challenge for a while, according to Gartside.
“This is an environment where fixed income returns are likely to continue to positively surprise investors,” he said. “Portfolios remain well positioned with a modest long duration bias and low risk levels. As we get greater clarity on the evolution of the eurozone response, we will also look to tentatively deploy our cash pile into riskier assets, such as investment grade, high yield and emerging market debt.”
