Although coronavirus vaccines bring hope for control of the Covid-19 virus and boost markets as a whole, if this generates a rapid economic recovery it holds the potential to fuel inflation. Throughout the pandemic, we have seen deflationary forces of the real economy push against the inflationary influence of policymakers’ response. The greatest danger going forward is that we experience inflation, but find that policy makers are behind the curve in making necessary adjustments.
If we get to the middle of the year and find we have a full-blown economic recovery along with inflation levels of 2% or above, all eyes will likely be on whether the central banks will start considering higher interest rates. If their reaction is too slow, we could see renewed pressure on risk assets and a wobble in the equities markets, resulting in a fall in bond yields.
With markets facing much uncertainty and a rise in inflation being likely at some point, this could prove a challenging year for bond-market returns. Those investors in bond strategies unable to adapt to the changing backdrop may run the risk of seeing returns eroded over time.
This said, concerns for inflation have been around for some time on the view that some of the long-term deflationary trends we have witnessed in recent years may be coming to an end. Demographic trends and signs that globalisation may be going into reverse suggest costs and prices will rise, with a greater emphasis on domestic production of goods in major markets and a return of inflationary pressure.
Although the potential for inflation is arguably higher than it was, bond market resilience remains strong, with opportunities to invest in new issuances from companies able to refinance at pretty attractive rates.
Paul Brain, head of fixed income, Newton Investment Management.
Doc ID: 355600