ETF Securities has published its Triannual collection of research. Focusing specifically on the inclusion of inflation linked bonds in a portfolio, Morgane Delledonne, Associate Director, Fixed Income Strategist comments that inflation-linked (I/L) bonds generally outperform nominal bonds in times of rising inflation and growth by an average of 3 per cent.
Delledonne writes that I/L bonds remain better for long-term capital protection rather than short-term inflation hedging.
“We found that including I/L bonds to a portfolio reduces volatility and improves risk-adjusted returns. I/L bonds are also efficient instruments for improving diversification. Moderate inflation outlook inflation expectations are the biggest driver of rising long-term yields together with expectations on future short-term interest rates.
“The breakeven inflation rate (difference between the yield of a nominal Treasury bond and the yield of an inflation indexed Treasury bond of the same maturity) reflects inflation expectations and the risk premium for uncertainty about current inflation.
“The US 10yr breakeven yield fell below 2 per cent from 2014 to 2015 alongside the drop-in commodity prices and the perceived risk of deflation. Then, it rebounded drastically in August 2016 in anticipation of tighter monetary policy, Trump’s pro-growth policies and a better outlook for energy prices. Most market and survey-based inflation expectation indicators are now close to Fed’s inflation target of 2 per cent.
“However, the 10 year-five year breakeven spread has fallen to zero recently, suggesting that market participants are expecting a rise in inflation in the short term but are not yet convinced that inflation will continue to accelerate over the next decade.
“We believe that structural headwinds such as an ageing population, low productivity growth and a global debt overhang problem will likely prevent the economy from overheating, thus reducing the chances of inflation rising higher over the longer-term. Meanwhile, the volatility in commodity prices is likely to continue to translate into volatility in inflation metrics.”
Nitesh Shah – Director –Commodity Strategist at ETF Securities has focused on metals for the research report. The extraction and production of commodities has been highlighted as a cause for environmental concern, particularly in Emerging Markets, he writes.
“Both China and the Philippines are taking a tougher stance on environmental protection. China is the largest producer of aluminium and Philippines is the largest producer of nickel. Both metals are at risk of supply deficits as a result of new environment policy.”
Shah writes that China has a pollution problem. According to the China Statistical Yearbook, 60 per cent of groundwater is unfit for human consumption.
“Of the 161 closely monitored cities, only 16 cities reached the national standards of air quality. While the Chinese authorities may have delivered on superior economic growth for decades, its record on delivering better environmental outcomes has not been as good.
“Its fragile one-party political system relies on social peace. That is difficult to achieve if the population is annoyed with the state of the environment. According to recent surveys, air and water pollution are respectively the second and third most pressing problems for Chinese households. They rank ahead of income disparity, worker conditions and unemployment. According to Beijing News, environmental pollution was the cause for close to 50 per cent of all mass disturbances involving more than 10,000 people.”