Industry Voice: Rising Inflation Risk and How to Address It

Inflation risk can be mitigated by using inflation-linked bonds, cyclical assets, and high-yielding bonds with low duration

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Industry Voice: Rising Inflation Risk and How to Address It

For more than a decade, inflation has not been regarded as a major investment risk. Indeed, since the global financial crisis, deflation has been seen by many as a bigger threat—policymakers in Japan and the eurozone have been struggling to push inflation up, not down. With inflationary pressures now building across the world, though, this could change.

U.S. Inflation Expectations Are Anchored Despite CPI Spike

(Fig. 1) Recent realized inflation has been highly volatile

U.S. Inflation Expectations Are Anchored Despite CPI Spike

As of August 31, 2021.

Sources: U.S. CPI Urban Consumers YoY (U.S. Bureau of Labor Statistics), Euro Area MUICP All Items (Eurostat), UK CPI EU Harmonized YoY (UK Office for National Statistics), Japan CPI Nationwide YoY (Ministry of Internal Affairs and Communications), U.S. Breakeven 10 Year. Analysis by T. Rowe Price.

At present, the market‑implied 10‑year‑forward inflation expectation for the U.S. and most other developed countries remains relatively muted, reflecting widespread assumptions that the current inflation spike may prove temporary. Figure 1 shows the year‑on‑year (YoY) changes in consumer price indices (CPIs) for the U.S., the eurozone, the UK, and Japan as well as the market's expected rate of inflation in the U.S. (10‑year breakeven inflation rate of inflation‑linked government bonds). It reveals that while inflation has recently spiked across the U.S., the eurozone, and the UK, expected inflation remains relatively anchored—and indeed has been more stable than realized monthly inflation for an extended period. In Japan, inflation is still in negative territory.

 

 

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