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Wall Street Pros From Goldman to JPMorgan on New Inflat...

Business Maverick

Business Maverick

Wall Street Pros From Goldman to JPMorgan on New Inflation Era

Pedestrians pass in front of Goldman Sachs headquarters in New York. Photographer: Michael Nagle/Bloomberg
By Bloomberg
23 Mar 2021 0

It’s the invisible force rocking Wall Street: An inflation revival for the post-lockdown era that could change everything in the world of cross-asset investing.

As America’s dalliance with run-it-hot economics sends market-derived price expectations to the highest in more than a decade, Bloomberg solicited the views of top money managers on their make-or-break hedging strategies ahead.

One takeaway: The economics of trading from stocks and real estate to interest rates would be turned upside down if projections of runaway prices are to be believed.

Yet there are clear divisions. Goldman Sachs Group Inc. says commodities have proven their mettle over a century while JPMorgan Asset Management is skeptical — preferring to hide in alternative assets like infrastructure.

Pimco, meanwhile, warns the market’s inflation obsession is misplaced with central banks potentially still set to undershoot targets over the next 18 months.

The comments below have been edited for clarity.

Alberto Gallo, partner and portfolio manager at Algebris

  • Likes hedges including convertible bonds and commodities

We don’t know at this point if the inflation pick-up will be sustained, but it’s a good start. What we do know is that markets are positioned completely the wrong way. Investors have been long QE assets like Treasuries, investment grade debt, gold and tech stocks. They’ve been long Wall Street and short Main Street for a decade.

There will be rotation into real-economy assets such as small caps, financials and energy stocks instead of rates and credit, and that will generate a lot of volatility. We like convertible debt in value sectors which are linked to an acceleration in the cycle. We also like commodities.

We are turning from an environment where central banks pushed the accelerator by keeping interest rates low while governments pulled the handbrake with austerity, to one where governments and central banks are now working together.

Thushka Maharaj, global multi-asset strategist at JPMorgan Asset Management

  • Prefers real assets over commodity and price-protected bonds

Commodities tend to be volatile and do not necessarily offer good inflation protection. As for index-linked bonds, our study showed their long duration outweighs the pure inflation compensation this asset offers. It’s not the top asset on our list of inflation hedging.

If inflation were to rise and continue rising — and we think that’s a low probability event — equity sectors that are geared toward the recovery provide a good investment profile. We also like real assets and the dollar.

We are expecting volatility in inflation, especially at the headline level over the next few months, mostly over 2Q, driven by base effects, excess demand in the short term, and disruption in supply chains caused by a long period of lockdown. We see this as transitory and expect the central banks to look through the near-term volatility.

Christian Mueller-Glissmann, managing director for portfolio strategy and asset allocation at Goldman Sachs Group Inc.

  • Issues warning on index-linked bonds and gold

We found that during a high inflation backdrop, commodities, especially oil, are the best hedge. They have the best track record in the past 100 years to protect you from unanticipated inflation — one that’s driven by scarcity of goods and services, and even wage inflation like that in the late 60s. Equities have a mixed tracked record. We like value stocks as they are short duration.

The biggest surprise is gold. People often see gold as the most obvious inflation hedge. But it all depends on the Fed’s reaction function to inflation. If the central bank doesn’t anchor back-end yields, then gold is probably not a good choice as real yields might rise. We see index-linked bonds as in the same camp as gold.

A scenario of sustained inflation above 3% and rising is not our base case, but that risk has definitely increased compared with the previous cycle.

Nicola Mai, sovereign credit analyst at Pimco

  • Says inflation might undershoot central bank targets over next 18 months

Looking through near-term volatility introduced by energy prices and other volatile price components, we see inflation remaining low in the near-term, with central bank inflation targets elusive over the next 18 months or so. The global economy has spare capacity to accommodate rising demand. If the spending were to be increased steadily over years, however, this would likely end up in higher inflationary pressures.

We broadly like curve strategies and think U.S. TIPS offer reasonable insurance for an inflation overshoot. Commodities and assets linked to real estate should also benefit in an environment of rising inflation.

Mark Dowding, chief investment officer at BlueBay Asset Management

  • Pares duration risk and warns on market complacency

Real assets such as property and commodities will hold value best in inflationary situations. Duration exposure on bonds is not attractive as yields should head higher over a number of years if inflation normalizes at a higher level than we have been used to. The most overlooked risk is that there is too much complacency because everyone’s inflation expectations are anchored based on what they have witnessed in the past five to 10 years.

If there is a renewed economic slump, policy makers will be in a difficult position. Hence there is desire to make sure that you don’t miss targets on the downside. Like a golfer hitting a ball over a scary hazard, there is a temptation to go big! Ultimately this means that inflation outcomes should be higher not lower.

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