Fears of Deflation Considered Excessive by Senior Analysts

Alexandra, Singapore, July 31, 2015 (Newswire.com) - Norton Global Asset Management sees deflation fears as excessive, with long-term inflation expectations having bottomed out earlier this year and moving distinctly higher since.

For instance the European Central Bank (ECB) President Mario Draghi’s preferred inflation indicator - the 5 year-5 year (5y5y) forward expected rate of inflation – for example. This benchmark of market forecasts for inflation over a five-year extent starting in five years’ time bottomed at 1.5 per cent in January and is currently at 1.8 per cent, close to the ECB’s target of 2 per cent inflation.  

Longer-term inflation forecasts have followed a similar sequence in the US and UK, so concern that deflation would become entrenched in market prices have clearly diminished. Similarly, these forecasts continue to stay moderate - currently respective 5y5y forward inflation forecasts were 2.4 per cent and 3.5 per cent for the US and UK (using the higher RPI for the UK figures).

Where underweight assets that would normally profit from deflation (notably high-value government bonds) over assets that profit from continued economic growth and moderate inflation. These would contain assets that provide a thriving and above-inflation income stream, with the likes of dividend-paying equities along with investments in commercial property.

Both of those asset classes may seem less attractive after recent strong performances, recommendation is still to back exposure to these growth assets. For instance, Norton Global expect UK commercial property to show greater returns than corporate bonds, with returns being boosted by rental growth against a backdrop of a strong UK economy.

With regard to income-orientated portfolios, preference is for emerging-market and high yield bonds, while there is some good potential  to be found in risk-adjusted opportunities in ‘favorable situations’ debt (bonds of companies that are currently restructuring, offshoots, mergers etc.) for greater income and less interest-rate sensitivity against the ‘safer’ government and corporate bonds with that have higher credit-quality ratings.  

Lastly, Norton Global Asset Management are very prudent when it comes to inflation-linked bonds, which is felt are actually misnamed. Historically, returns for bonds of this type have generally moved inversely to inflation even over a medium- to long-term perspective. This shows their sensitivity to high interest-rates and shows that significant degrees of inflation (commonly known as the breakeven rate) are already priced into the securities.

Alternatively, they should be treated as approximately 90 per cent high-duration bonds with about 10 per cent inflation protection. Overall, preference it for reducing clients exposure to rate-sensitive assets that can profit from deflation in favor of others that are more likely to profit from a continual modest firming in inflation expectations.