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    Will Inflation be the Big Disruptor for Fixed Income in 2021?

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    With Bitcoin soaring over the festive period, it’s been easy to overlook concerns about Inflation. Should Fixed Income teams in Banks worry about Inflation in 2021? The answer is a definite ‘Yes’. But perhaps not why you think.

    When Tyler Winklevoss shared, at the Singapore Fintech Festival last month, how companies like MicroStrategy and Square were investing in Bitcoin, it became clear that something was afoot:

    Couple that with all the talk about both Negative Interest Rates and the potential that banks will soon be charging for using bank accounts, it is no surprise that companies are trying to find new ways to make their cash work for them.

    Many of them, hit by crippling debts on the back of the pandemic, are issuing corporate bonds.

    Bond Markets are touted as being good places to invest when there is a Bear Run. And, many of us thought 2020 would be a Bear Run. 2021 isn’t looking much better for now, what with all the delays in distributing the vaccine. Fixed Income in 2020 and 2021 are not as predictable as they may have been in the previous decade. We might have had a Bear Run in March affecting nearly every market globally, but then we have also seen a Bull Run on many equities markets too.

    How do you plan for this level of disruption?

    The Big Disruptor of Fixed Income and the Bonds Markets in the current market conditions, is inflation. With all the debt and economic stimulation in 2020, bonds have performed ‘adequately’, The question is not so much about which Bonds to invest in, but about the underlying Risks involved:

    Central Banks may have to buy government debt, but that doesn’t mean that your average institutional or private investor has to. Depending on your risk appetite, there are plenty of high-risk corporate bonds out there too. Especially if we turn East:

    CHINA

    Ray Dalio, Founder of Bridgewater shared with the FT last week:

    “China already has the world’s second-largest capital markets and I think they will eventually vie for having the world’s financial centre,” Mr Dalio said. “Throughout history, the largest trading countries evolved into having the global financial centre and the global reserve currency. When you see the transition from one empire to another, from the Dutch to the British to the American, to me it just looks like that wall over again,” he added in an interview with the FT in mid-December, shortly before the death of his son.

    According to the IMF, China’s economy will have grown about 1.9 per cent last year.

    “I have been immersed in China since 1984 and bullish on China for a long time… and all the time I got scepticism – up until now,” Mr Dalio said.

    “The capital markets are not only growing, they’re good investments and the world is underinvested there.”

    In their piece, Morningstar seem to agree with Dalio. Adding that some companies are expecting China to become an increasingly important part of the bond universe, and the country’s debt offers an alternative for investors to developed market bonds.

    INFLATION IN 2021:

    U.S. Treasuries are frequently the starting point of discussions when it comes to Inflation, and some commentators believe that returns on these bonds should increase through 2021:

    In December’s Press Release by the Federal Reserve, inflation was discussed multiple times. Some of the most important sound-bites included:

    • Inflation was projected to overshoot 2 percent by a moderate amount, beyond 2023
    • Increases in consumer prices had been soft of late which meant that downward pressures on inflation would start to abate in 2021
    • Technology-enabled disruption to business models and practices or lasting pandemic-induced restraint on firms’ pricing power, means that downward pressure on inflation could persist
    • With continued monetary policy support, inflation will rise over time
    • Inflation may rise if there is a stronger-than-expected recovery

    In summary, one of the key takeaways from the Committee’s meeting was the below sentiment:

    “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”

    FIXED INCOME

    Sir John Redwood, Chief Global Strategist for Charles Stanley, shared with the FT last week the following words about Inflation and his thoughts about investing in China, the UK, the US, the EU or in Green Bonds:

    “2021 is billed as the year of build back better” Redwood shares, “The UK should see a good recovery from the hit it took last year, with forecasters expecting strong growth from the second quarter.

    “Europe remains at a disadvantage to the US and China, thanks to its lack of successful technology giants, such as Microsoft and Google on one side of the Pacific and Alibaba on the other.

    “Europe also lacks scale in green products, despite its enthusiasm for the green revolution, allowing China to gain a dominant position in batteries while the US is doing well in electric cars and solar power.

    “For the time being the advanced world is running on the Japanese model of borrowing and buying in the state debts with newly created money.

    “That works just as long as inflation stays down and confidence is retained.” Redwood concludes.

    With uncertain times continuing into 2021, the topic of inflation will not be faraway from many people working in the Fixed Income space. The biggest Disruptor this year might be Inflation, but if it isn’t then it will only be because the pandemic takes too long to resolve. Or, because Aliens land, which looking at 2020, doesn’t appear so unlikely anymore.

    For now, the reassurances of the Federal Reserve have to be enough for us to plan investment activities over the next few months.

    Author: Andy Samu

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