Amid Inflation Uptick, Valuations Signal Opportunities in Inflation‑Linked Assets

The persistence of elevated inflation has started to worry many market participants and central banks, because the longer CPI (consumer price index) inflation remains elevated, the higher the risk that inflation expectations accelerate. While the currently elevated levels of realized inflation do appear to have boosted inflation expectations, most forward expectations remain at or below monetary policy targets.

In recent communications, most central bankers appear to attribute the elevated inflation prints (at least partially) to global supply chain bottlenecks and associated scarcity of supply. Central banks could in theory influence this dynamic by raising policy rates, which would tend to stifle demand and ease some pressure on the supply side. But with major economies still shy of the central banks’ employment objectives, and with many of the current inflationary pressures likely to subside on their own, policymakers in the major developed economies have not yet started to raise rates.

This patient approach could feed investor demand to hedge their portfolios against future unexpected bouts of inflation.

  • In the U.S., our base case is for headline CPI inflation to peak around year-end and into Q1 2022, and remain elevated through Q3 2022 when some moderation is likely as the handoff from goods to services consumption returns to more normal levels. However, consensus inflation forecasts have been playing catch up with inflation, signaling that risks to the base case skew to the upside – for details, see PIMCO’s recent blog post, “October U.S. CPI Adds Pressure to Fed Policymaking.”
  • In Europe, supply chain breakdowns have contributed to deceleration in the Industrial Production measure and an acceleration in headline CPI. Volatility will likely remain elevated in the months ahead, with inflation expected to peak at close to double the European Central Bank’s (ECB) target, and then start to normalize – conditional on energy impacts weakening and a mild winter. ECB President Christine Lagarde recently acknowledged that rate hikes are very unlikely in the next year.
  • In the U.K., we see a similar picture as in the U.S., with the Bank of England (BOE) likely to remain patient given supply disruptions driving inflation. In fact, in early November, the BOE surprised markets by not hiking rates. Although we expect a later peak in U.K. CPI versus the U.S. and Europe, our forecasts call for inflation accelerating to over twice the BOE’s target.