AXA’s Jonathan Baltora decodes what coordinated QE, the Chinese consumption drive and negative real rates means for the fixed income world.
Printing presses and positivity
‘Quantitative easing is actually working better than a lot of market players may think. We believe that the non-standard monetary policies implemented by the Federal Reserve are very efficient because the US dollar is the world's reserve asset,’ said Jonathan Baltora, lead manager on the AXA WF Universal Inflation Bond fund.
‘Since the Fed has restarted QE, there is a lot of private borrowing in the US and this isn't only US companies needs being fulfilled but also international corporates taking advantage of the very accommodative financing conditions.’
‘A significant share of that money is actually spent outside of the US thanks to the US dollar’s privileged status.’
Negating the negatives
Baltora said: ‘Some investors have voiced concerns about negative real yields. It is true that this can be disturbing for fixed income investors but there is an easy way to explain this concept.’
‘The nominal yield for a sovereign can be broken down into real yield and inflation expectation. Real yields are correlated to nominal interest rates and turn negative when inflation expectations are higher than the nominal yield.’
‘In such a context nominal bonds will yield less than future inflation therefore this is a natural buy signal for inflation linked bonds.’
‘The Chinese growth model is evolving from ‘produce to export’ to ‘produce to consume’. This means that China needs a middle class and increasing wages. Wages have been increasing at between 15% and 20% a year while inflation has been hovering around 4%,’ said Baltora.
‘Various institutions have estimated that the former Chinese export-led growth model has shaved 1% off the world's inflation every year. This means that we should be ready for a least 1 more per cent of inflation.’
UK leads the way
‘We should expect to see inflation forecasts consistent with the Bank of England inflation targets. Central banks in general do not acknowledge the new inflation regime and the stickiness of prices,’ explained Baltora.
‘Moreover the recent depreciation of the pound means that there is a clear upward inflation risk in the next 12 to 24 months.’
Baltora concluded: ‘We have estimated that in most advanced economies 1% to 2% more inflation will have a significant impact on the debt to GDP trajectory meaning that there is an incentive for central bankers to tolerate more inflation.'
'Flexible inflation targeting means more inflation and also probably more volatile inflation, hence the need to be protected.’