Funds pile into gold, commodities and inflation-protected bonds as hedges for price rises
Jennifer Ablan
Everything worked in 2019. US stocks, junk bonds, silver, oil, bitcoin and even Greece-focused exchange traded funds posted stunning gains, boosted by easy central bank policies.
Now new risks lurk, as the US Federal Reserve continues to keep interest rates low and pursue monthly liquidity injections, as well as purchases of Treasury bills at a similar magnitude as previous rounds of quantitative easing. Such efforts have helped to send nearly every asset class into “bubbly” territory.
But a growing band of voices on Wall Street is warning of a possible consequence of this ever-looser monetary policy: inflation, which could dominate headlines this year for the first time in many.
Jeffrey Gundlach, chief executive of DoubleLine Capital, said it was a remarkable day for financial markets in late October, when Fed chair Jay Powell said he would need to see a “really significant move up in inflation that’s persistent, before we would even consider raising rates to address inflation concerns”.
For Mr Gundlach, whose firm manages $150bn in assets, the key word was “persistent.” He described it as “momentous” that Mr Powell was “now one of the leading inflation cheerleaders in the system. Higher inflation is now the goal of the Federal Reserve chairman. Can’t people see what a big shift this is?”
Worrying about inflation would certainly make a reversal from the past decade or so, when market watchers have been more bothered about deflation. Central banks have pulled out the stops to avoid sinking into the low-growth, low-inflation mire of “Japanification”.
The Fed cut interest rates three times last year, taking its target range for short-term borrowing costs to 1.5 per cent to 1.75 per cent.
The US central bank has a dual mandate of stable prices and maximum sustainable employment, “but unemployment is at a 50-year low, so why would they cut rates three times in three months?” said Richard Bernstein of Richard Bernstein Advisors. “It must be their concerns about deflation. Or put another way, not enough inflation.”
Mr Bernstein and Mr Gundlach note that Mr Powell’s push for more inflation is coinciding with moves by Donald Trump, US president, to relax fiscal constraints. The US government’s annual budget deficit swelled to $984bn in fiscal 2019, the most in seven years, as a drop in tax revenues coincided with higher military spending. The deficit is expected to top $1tn this year, theoretically feeding inflation.
At the same time, the effects of the long trade war with China may work their way through into higher consumer prices. The reason the US has not seen more inflation so far from tariffs is that companies are absorbing extra tariffs and accepting the squeeze on their margins. “That’s unlikely to continue in 2020,” said Mr Bernstein.
As a result, Mr Bernstein said his firm, which oversees $9.3bn of assets, has big positions in Treasury inflation-protected securities, or Tips. Such bonds, which pay investors a fixed interest rate as the bond’s par value adjusts with the inflation rate, are the “most straightforward way” to safeguard portfolios from inflation, said Kathy Jones, chief fixed income strategist for Charles Schwab.
Mr Gundlach also favours Tips as well as gold, commodities and emerging market assets, which tend to benefit from a weaker dollar, knocked down by inflation. He said a lower dollar was his highest-conviction trade for the year.
“We’ve suggested we are revisiting That ’70s Show, but not the late-’70s,” said Mr Bernstein, referring to the TV sitcom. “The inflation spirals of the ’70s didn’t start with everyone worried about inflation.”
Some parts of the market are catching on. Investors poured $208m into US-based Tips funds in the week ended January 15, according to Lipper data. That was the fifth consecutive week of inflows.
The softening dollar, meanwhile, is unleashing flows into commodity-linked funds, according to Jason Bloom, senior director of global ETF strategy and research at Invesco. He said such funds serve as a “powerful inflation hedge”.
Others are also piling into gold, the classic inflation hedge. Bridgewater Associates, the world’s largest hedge fund with $160bn in assets under management, sees gold prices, currently about $1,550 an ounce, eventually moving beyond $2,000 in an environment of lower rates and the Fed’s embrace of higher inflation.
The plaudits paid to former Fed chair Paul Volcker, who died late last year, focused on his victory over inflation in the 1970s.
His tenure demonstrated that inflation, once unleashed, is not easily tamed. It is understandable that investors are getting nervous about looser talk.
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