“There is an inherent disjoint within bond markets, and the market is extrapolating current trends far too far into the future,” he said. “There is a high correlation between inflation expectations and commodity prices, which is naïve – particularly in developed markets where 75-80% of the economy is service-based.
“The key thing for future inflation is what happens to wages. UK labour markets are already tight, there are already signs of wage inflation coming through and there is also the national living wage coming through to 2020.
Doran continued: “There is overly accommodative monetary policy, and as wage pressure starts to build it will be a trigger for future higher inflation. The base effect of the commodity price drop will start to fall out of the figures, and headline inflation will start to gravitate back towards where core inflation currently is, which is above current market inflation expectations.”
“Inflation expectations are too low and real yield expectations are too low. We will get an increase in government bond yields – it is not inconceivable that we will see UK 10-year sovereigns back up at 4% within the next three or four years, and this is when they will become attractive again.”
‘Liquidity crisis’ is a phrase that has been bandied about investment circles recently, usually prefixed with ‘impending’, but while Jones concedes there is liquidity risk within the high yield space, he is sanguine on its IG counterpart.
