I have added a 5% allocation to US inflation linked bonds and a 5% allocation to UK index linked gilts in the Active Asset Allocator, funding both positions from cash. The cash weighting moves from 20% to 10% as a result. The bond market is pricing in almost no inflation in our future and I believe that is a mistake. Printing money always leads to inflation, eventually. We have experienced 7 years of asset price inflation (rising equity and property prices) and are starting to see increasing signs of wage inflation this year. In the United States, while inflation linked bonds continue to underperform Treasuries, technical signs of a change in trend are at hand. Relative strength (RSI) and momentum (MACD) indicators are improving in favour of inflation-linked bonds and price should follow suit later this year.
Inflation linked bonds are also rallying in the United Kingdom and the recent 15% drop in GBP should accelerate this trend. Falling unemployment, wage inflation and continued loose monetary policy by the Bank of England should provide an additional tailwind.
Central banks have already driven government bonds yields to zero or below and are now examining alternative ways to distribute a continuing flow of newly printed money. Accelerated fiscal spending and/or direct payouts to the public (helicopter money) are potentially on the cards. I expect the bond market to start pricing in a more inflationary outlook and inflation linked bonds should be a beneficiary. The Active Asset Allocator continues to hold a 20% allocation to fixed interest rate bonds, but the clock is ticking on this trade. The 35+year bull market in fixed interest rate bonds is in its final innings and I have one eye on the exit door.
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