Global Inflation: Risk scenarios are generally tilted on upside - Natixis

According to René Defossez, Research Analyst at Natixis, the trend has been for a gradual upturn in investor appetite for linkers and the explanation lies in the fact that investors expect inflation to be near, if not greater than official central bank targets in countries having issued the most linkers, added to which nearly all risk scenarios for inflation are tilted on the upside (US: aggressive trade policy; UK: sterling’s depreciation then, over the medium term, the introduction of customs tariffs on goods imported from the EU; Eurozone: populist policies).

Key Quotes

“Having said that, in February, breakeven inflation rates did not rise everywhere. In the case of the 10-year Bund€i, it declined by 10bp, even though Eurozone headline inflation stands at 2% and the VIX is very low. This poor performance is explained mainly by the stabilisation of crude oil prices and the decline in nominal yields.”

“For much the same reasons, the breakeven inflation rate for the 10-year TIPS stabilised just above 2%.”

“Even more remarkable was the nearly 40bp decline in the breakeven inflation rate for the 10-year index-linked Gilt, due to a great extent to the sharp fall in British nominal yields (the spread between nominal yields for the 10-year Gilt and Bund narrowed by 20bp over the month).”

“Our strategy to play a widening of the spread between the 10-year swap on French inflation and the 10-year swap on Eurozone inflation performed beyond our expectations, as this spread reached 18bp at its widest. The rational largely has to do with the French presidential election (several factors, some tugging in opposite directions, created a fair amount of noise in this spread, including François Fillon’s proposal to increase the VAT rate and to reduce incentives for tax-free short-term saving products, not to speak of the not insignificant probability of a victory of Marine le Pen).”

“Finally, the box between breakeven rate for the 10-year Bund€i and BTP€i rose last month, even though the 10-year BTP-Bund spread tended to tighten. The correlation between this box and the sovereign spread has weakened these past few weeks.”