Inflation continues to remain a driving force in market speculation and the concerns of investors, as it has for much of the year. With inflation continuing to persist, T. Rowe Price believes that investors should plan for higher premiums to account for inflation, according to a recent white paper.
Inflation keeps hitting new peaks in developed markets globally as economies work to reopen, supply chain issues create pressure, and energy prices soar before winter, exacerbated by natural gas supply issues. The crunch is being felt worldwide; in the U.K., the price pressures are near 10-year highs, and within the U.S., annual consumer prices are at their highest since the financial crisis in 2008, reaching above 5%.
“Given the conditions, it may be prudent for fixed income investors to factor a higher premium for the inflation risk,” says Arif Husain, portfolio manager and head of International Fixed Income at T. Rowe Price.
Bond markets are currently positioned with interest rates near record lows, reflecting a belief by most investors that the inflation being experienced is only temporary. It’s a belief that Husain cautions will grow increasingly riskier over time if prices maintain their current highs.
What’s more, central banks in developed markets are taking a mostly hands-off approach with regards to rising inflation, believing that it is transitory and potentially encouraging higher levels of inflation.
“The current price spike could act as a potential opportunity for select developed central banks to reset inflation expectations higher after years of failing to meet their price target,” explains Husain.
An active management approach allows for flexibility in response to changing inflationary pressures and environments. The year has already seen the need for a variety of approaches, with the first three months favoring underweight duration positions that stood to benefit from increasing inflation within the U.S. and U.K., while mid-year changes meant that short-dated U.S. inflation-linked bonds performed well.
This pattern of underweight duration riding on the back of inflationary pressures has played out globally, across developed and emerging markets, and continues to be an approach that investors can capitalize on in many emerging markets.
An alternative investment opportunity also lies in short-duration positioning within developed countries where increases in prices could be considered to be more “structural,” Husain believes. Prices are only set to increase with the growing labor shortage exacerbated by supply chain constraints.
“I believe this theme of persistent transitory inflation will manifest itself at different times in various geographical locations, so while pressure may subside in one region, it could rise in another. It is, therefore, important to keep monitoring the conditions and adapting to them as they change,” explains Husain.
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