New York – In a landscape dominated by lackluster growth and low interest rates, many investors have left inflation for dead. However, this could be another case when the consensus view turns out to be wrong, with important implications for portfolios.
In fact, the Federal Reserve’s supposedly favorite measure of inflation expectations may have quietly bottomed last February. As shown below, the 5-year forward inflation breakeven rate has moved higher in recent months after testing a potential bottom twice in 2016. The breakeven rate is the difference in yield between nominal U.S. 5-year Treasuries and U.S. 5-year Treasury Inflation Protected Securities (TIPS). It shows the inflation rate at which the inflation-linked bond would outperform the nominal Treasury.
As we’ve written before, overall sentiment is very risk-averse now with investors piling into bond funds, while equity funds and ETFs have seen significant outflows. Our sentiment indictor, which is a measure of the consensus-recommended asset allocation by Wall Street firms, continues to show that strategists are recommending an underweight position in equities.
Anyone see the irony that “lower for longer” is now the widely accepted interest-rate forecast at a time when inflation expectations might be troughing?
Bottom line: Most equity and fixed-income portfolios seem incorrectly positioned if inflation expectations do indeed continue to increase.