Inflation hedges - the boy who cried wolf?

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Inflation hedges - the boy who cried wolf?

Despite concerns among Germany investors over how quickly the current low levels of eurozone inflation could switch direction, the question remains how many of them are actually prepared for a scenario of price rises.

For Björn Jesch (pictured), CIO and head of Portfolio Management at German asset manager Union Investment, the constant equating of economic challenges today with a Weimar Republic-type scenario is an absurdity: “We are currently facing a situation of 0.5% HICP inflation, yet I still encounter plenty of German investors who have started stockpiling gold in anticipation of a pending inflationary crisis.”

While German inflation rates marginally exceed the European average of 0.4%, Union Investment is sceptical of the idea that significant price rises in Germany are imminent.

“We don’t belong to the group of investors who anticipate a sharp rise in headline inflation.

“Yes, there will be an increase in price levels, partly due to rising commodity prices, and being late in the cycle, but we don’t believe that we are currently at the end of the cycle and over the next two to four years, we don’t expect a sharp increase in inflation rates,” Jesch stresses.

EARNINGS GROWTH PRESSURE

For Pioneer Investments, which recently launched a new inflation-linked bond strategy targeting among others the German market, the scenario is not quite as absurd.

“In Germany the output gap is closed and the labour market is very tight. We are seeing signs of domestically created inflation, even though it was offset by global effects like the sharp correction in oil prices or the euro currency appreciation. We are expecting wage inflation to pick up going forward and we believe current levels offer a good entry point to hedge for inflation risk,” comments Cosimo Marasciulo, head of European Government Bonds at Pioneer.

This view could be backed by rising household consumption data, as the latest ifo Institute survey suggests: such consumption increased by 0.4% through the third and fourth quarters, despite a decline in industrial output and GDP growing at a slightly slower pace.

“If we would look at a hypothetical scenario of prolonged risk of deflation, one should remember that inflation linked bonds are floored, so the potential loss would be limited, especially for more recently issued inflation linked bonds, and the bonds would appreciate in real yield terms,” Marasciulo adds.

SELECTOR VIEW

How then, do selectors position themselves in the debate? Vienna-based Florian Gröschl, managing director at ARC Consulting is cautious with predicting the exact timing of a change in price levels.

“We do, however, increasingly look towards asset classes which would function in an environment of rising inflation.

“Of course, everyone might have their own opinion on it, but for bonds this clearly means the longer the duration the less attractive they become. Commodities tend to benefit from inflation while the position of equities is a lot more ambivalent.

“Overall, stock market indices tend to suffer in times of rising inflation while individual industries, such as financials, could benefit.”

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