Spot the odd one out

Inflation markets

The below market consensus pricing of European and US inflation markets contrasts starkly with the picture in the UK. British investors looking for protection against a global (rather than country-specific) inflation shock could find better value overseas.

European and US inflation markets are priced meaningfully below the market consensus forecast. Traders are either not listening to their economist colleagues or, more charitably, they are worried about downside deflationary risks. 

This contrasts starkly with the picture in the UK. Economists and bond traders are in happy agreement that (RPI) inflation is set to rise steadily to 3%. It is possible that UK economists are simply more persuasive than their European and American counterparts.

Investors seeking inflation protection will likely find much better value in Europe and the US than in the UK.

However, this isn’t a particularly satisfactory explanation. There are two more plausible alternatives:

 

  1. The UK inflation market is better 'balanced'. The big seller of inflation (i.e. the government) is counterbalanced by willing buyers of inflation (i.e. pension funds) in a way that is not true in either the European or US markets.
  2. Inflation risks are more symmetric in the UK. Arguably there is downside skew to inflation risks globally due to demographic and technological change. Those risks are compounded by the inability of global central banks to drive up inflation expectations despite years of unorthodox monetary policy. However, this is plausibly offset in the UK market by the aftermath of the large post-Brexit depreciation in the exchange rate which poses upside risks to inflation.

 

Whatever the reason, the implication of this disconnect is that investors looking for protection against a global (rather than country-specific) inflation shock will likely find better value outside of the UK.

 

Given the growing evidence of firming wage pressure, the US market looks like an especially interesting proposition.

 
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