Bond Titans Ramp Up Growth Bets in Fight Against Deflation Fear

(Bloomberg) -- Calling for a resurgence in inflation has proved a fool’s errand all year but the likes of BlackRock Inc. and Eaton Vance are in fighting spirits as they bet in the bond market against economic doom and gloom.

As recent data undercut the case for recession and deflation, just a modest rise in price expectations which are still close to multi-year lows would boost long positions in so-called breakeven trades, according to fund managers.

With developed market bonds flashing price stagnation for the next decade, the thinking goes that fixed-income strategies betting on a firmer inflation trajectory look too attractive to pass up.

“Our view around inflation continues to be more positive than the market is pricing,” said Scott Thiel, BlackRock’s chief fixed-income strategist. “If financial conditions stayed where they were, we would get a situation where growth would effectively bottom and then re-accelerate back into more positive territory.”

Thiel likes index-linked bonds in the U.S. and northern Europe, and sees the potential for a 15 basis-point upward move in breakeven rates across the board.

Practically no one is betting on runaway inflation. But the BlackRock investor is not alone in eyeing a stronger price outlook relative to market expectations, even after this month’s upward move in U.S. breakevens driving nominal Treasury yields higher.

Merian Global Investors has been adding to breakeven trades over the past two months, with long positions in France, Italy and Germany. Eaton Vance touts cheap breakevens in Australia and New Zealand in its Global Macro strategy and its Short Duration Strategic Fund.

Buoyed by monetary stimulus and the prospect of government spending around the world, Amundi SA still talks up U.S. 10-year breakevens.

“The Fed’s easier stance could provide a floor to the currently very depressed level, particularly if the recent escalation of trade war recedes somewhat,” said Vincent Mortier, deputy CIO at the 1.56 billion euro ($1.7 billion) manager.

It may not take much to move the needle, amid signs economic data may be bottoming out relative to expectations. In Germany, domestic demand has held up despite trade weakness. The country’s sale of index-linked bonds due in 2030 this week drew bids 2.3 times the amount on offer, an increase from the average cover of around 1.6 times in the first half of the year.

Lower oil prices relative to October last year may also be “skewing” the price outlook to the downside, according to Dariush Mirfendereski, the London-based global head of inflation trading at HSBC Bank Plc.

“If you believe base effects are more one-offs -- and not a predictor of the next 10 years -- then any overshoot or undershoot of rates could be an opportunity to be a contrarian investor,” he said. “The longer the maturity of the bonds, the better this type of trading strategy is likely to work.”

With signs the U.S and China may be rolling back on tariffs to work toward a deal, machinations in global commerce could prove a win-win for inflation-protection investing.

Easing tensions are likely to juice short-term price expectations via improved business and consumer confidence. But BlackRock, Eaton Vance and Merian Global Investors warn the longer-term threat of protectionism risks higher inflation through tariffs, disruption of supply chains and exporters shifting to consumption-led growth.

“When the trade war heats up, inflation expectation falls due to the demand shock nature of the trade war -- which shows me that markets are trading as if weaker demand will lower inflation,” said Eric Stein, co-director of Global Fixed Income at Eaton Vance. “They ignore the supply-side effects of higher tariffs, which could lead to higher inflation. Breakevens are very attractive place to invest.”

For Merian Global Investors’ Mark Nash, the improved outlook in China and a softer dollar -- keeping global financial conditions easy -- could also help lift the price outlook, including in the euro zone where expectations remain not far off record lows.

“The risk-reward is quite good as such low inflation is expected now,” said the London-based head of fixed income.

It all suggests the interest-rate market could end 2019 on a more buoyant note on the economic trajectory relative to the recent angst.

“The market is too pessimistic,” said Jim McCormick, global head of desk strategy at NatWest Markets. “Across much of the G-10 countries, wages are rising. Yet the inflation market implies we are staring at deflation risks.”

To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Sid Verma, Todd White

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