Warning over inflation surprises

Investors have been warned about three technical factors driving this year’s inflation surprises, by a bond fund manager. The warning comes after many market indicators are discounting inflation rising, despite the fact that central banks are expected to start normalising policy, particularly in the US.

Jonathan Baltora, manager of the AXA WF Inflation Short Duration Bonds, said that firstly, wage inflation is stronger than reported in the news. This is because one of the main measures for wage inflation, statistics from the US Bureau of Labor, includes workers re-entering the workforce and who may be taking wage cuts to find a job. When only those in work are measured, wage inflation is higher, showing that it might be understated.

Secondly, he said short-term moves can drive long-term sentiment towards inflation. Baltora added: “But rather than investing in inflation-linked bonds when inflation expectations are rising, investors may find it more prudent to look at when inflation expectations have disappointed (and are therefore likely to rise).”

Baltora added that while the US Federal Reserve has seen inflation below its 2% target for some time, this is partly due to the nature of its inflation index and to one-off factors. “However, the impact of these factors will fall out of the annual inflation data towards the middle of 2018, allowing investors to differentiate short-term influences from longer-term trends. Given this, we believe that inflation will continue to normalise as the US output gap gradually closes,” Baltora said. He added that as markets normalise, even a gradual increase in inflation will mean a lot to investors.