BlackRock, Lombard Say Faster Inflation Calls Are Premature

Market expectations for a sustained rise in inflation and withdrawal of policy support are misplaced, creating buying opportunities in corporate bonds, according to BlackRock Inc. and Lombard Odier.

In an environment where growth is picking up but price gains likely to be transient, Lombard favors longer-dated corporate debt in China and India, said Dhiraj Bajaj, head of Asia credit. BlackRock likes high-yield corporate paper and Chinese securities, according to Neeraj Seth, head of Asian credit in Singapore.

The growing debate over the global inflation outlook is dividing investors into two camps, with Bill Gross and Bridgewater Associates primed for price pressures to shoot higher, while others argue that the recent market selloff on those fears will correct. Investors will be scrutinizing the Federal Reserve’s projection for the policy outlook Wednesday for clues to back up their arguments.

“Fears of inflation and more importantly concerns on Fed policy shifts are premature,” Neeraj Seth, BlackRock’s head of Asian credit in Singapore, said in an interview. While short-term price growth may accelerate as economies re-open, the trend is likely to prove “transitory,” he said.

BlackRock, Lombard Say Faster Inflation Calls Are Premature

Others including Pacific Investment Management Co. and Guggenheim Investments have also argued that a breakout in inflation and interest-rate risks are overplayed. Guggenheim’s latest note said data show underlying price gains are slowing. Aberdeen Standard Investments expects some inflation in the U.S., though it won’t be “sky high.”

In Europe too, any pickup in consumer prices may be fleeting. “If you look through all of the noise, the pandemic is ultimately deflationary and that will at some point show in the numbers,” ING analysts including Carsten Brzeski wrote in a note to clients on Tuesday. They see inflation in the euro-zone increasing over coming months before falling well below 2% in 2022.

For both Seth and Bajaj, the recent selloff and their longer-term views on inflation mean that there are opportunities to add to their holdings. Corporate bonds are now cheaper, according to Bajaj.

Credit “has become more attractive since the start of the year -- there’s no question about that,” he said. “The most logical thing to do is to buy more or to increase duration.”

Increase Duration

In his Asia Value Bond fund, which has beaten 96% of its peers in the past three years, duration has been increased to 1.4 years above the benchmark since the start of 2021. Bajaj said he plans to buy more longer-dated bonds if Treasury yields rise toward 1.8% to 1.9%, adding that the worst of the selloff is probably over.

“For the higher quality high-yield and investment grade, we are increasing duration,” said Bajaj. “But for the lower quality emerging markets and the frontier markets, we’ve reduced exposure since the end of last year.”

Treasury yields traded above 1.64% on Wednesday, the highest in more than a year, with some forecasting that it could climb toward 2%. U.S. 10-year breakevens -- a gauge of the bond market’s inflation expectations -- traded above 2.30%, the highest level since 2014.

“As the dust settles in the wake of today’s FOMC, we will be focusing upon whether any additional back-up in yields is accompanied by a further widening of breakevens,” said Richard McGuire, the head of rates strategy at Rabobank. “If so then this argues that the move higher in rates is sustainable.”

But as long as U.S. yields don’t rise in a chaotic fashion, risk assets including emerging-market and high-yield corporate debt are expected to outperform, according to BlackRock’s Seth. “Rates can drift higher and still remain a positive backdrop for the risk assets, as long as the vulnerability is under control,” he said.

A Bloomberg Barclays index on global credit returns has gained 11% over the past year, compared with a loss of 2% for a gauge tracking Treasuries. BlackRock switched to a neutral duration position in February from underweight. The fund likes notes sold by Chinese real estate companies and the nation’s onshore bonds.

“The lack of correlation with the rest of the global developed markets also provides a diversification benefit,” Seth said of Chinese debt.

©2021 Bloomberg L.P.

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