uk inflation expectations since the eu referendum uk... · uk inflation expectations since the eu...

UK inflation expectations since the EU referendum

Jonathan Baltora, Fund Manager

This presentation is for qualified investors and professional clients under MiFID (2004/71/CE) only and must not be relied upon by retail clients.

Circulation must be restricted accordingly.

#AXAIMFixedIncomeDay

Impact of Brexit on UK inflation

1

We have little doubt that Brexit should bring more inflation to UK shores

We expect UK inflation to accelerate in the coming months as the GBP depreciation in the currency market is expected to yield more inflation

Based on past currency depreciation experiences in the UK we anticipate every 10% of currency depreciation to add 0.5% to 0.7% of inflation to the UK economy in the subsequent 12 to 18 months.

Source: Bloomberg, 31/08/2016. Developments of the past offer no guarantee and are no indicator for any future returns or trends.

%

Index =

100


2

Market pricing of future inflation is still lower than a year ago

While we expect inflation to accelerate in the UK, the market pricing of future inflation is at level last seen during the RPI review in 2012…



3

Bank of England easing while inflation moves higher is traditionally ‘Linkers* friendly’

While inflation is still expected to accelerate, the bond market has rallied sharply thanks to a very accomodative Bank of England.


* Linkers: UK domestic inflation linked bonds.

Brexit and inflation-linked bonds

4

UK inflation expectations have outperformed other markets over the summer

UK inflation expectations have been moving up over the course of the summer. Other markets like US TIPS haven’t been incorporating the prospects of more inflation so far.


* Linkers: UK domestic inflation linked bonds.

Impact of Brexit on inflation-linked bonds

5

UK real yields look expensive on a cross-market basis

Source: Barclays Indices, AXA IM as of 31/08/2016 and Federal Reserve Bank of San Francisco: http://www.frbsf.org/economic-

research/publications/economic-letter/2011/october/unconventional-monetary-policy-lessons/

Developments of the past offer no guarantee and are no indicator for any future returns or trends..

UK Real Yields have been quick to react to the Brexit vote.

UK average real yields are now more than 1% richer than in the € area or the US.

-2

-1

0

1

2

3

4

%Inflation Linked Bonds Average Real Yields (%)

UK Govt Inflation-Linked All MaturitiesUS Govt Inflation-Linked All MaturitiesEura Area Inflation-Linked All Markets ex Greece

Lehman € Crisis

Pre-crisis Real Yield

“New normal”

“QE regime”

Inflation

6

We believe that inflation-linked bonds are attractive globally

US & euro inflation markets price in as much inflation as the most conservative economists

The market’s conservative pricing can be explained by multiple inflation disappointments over the past three years.

We find the market to be generally conservative and to price in less inflation than both Central Banks targets

and economists.


-1,0%

-0,5%

0,0%

0,5%

1,0%

1,5%

2,0%

2,5%

Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18

€ Zone : Headline Inflation

BCAP DB SG

NOM BNPP JPM

BoA ML Swaps Mkt Final

-1,0%

0,0%

1,0%

2,0%

3,0%

4,0%

Jan-

13

Apr

-13

Jul-1

3

Oct

-13

Jan-

14

Apr

-14

Jul-1

4

Oct

-14

Jan-

15

Apr

-15

Jul-1

5

Oct

-15

Jan-

16

Apr

-16

Jul-1

6

Oct

-16

Jan-

17

Apr

-17

Jul-1

7

Oct

-17

Jan-

18

Apr

-18

Jul-1

8

USA: Headline Inflation (% YoY)

BCAP DB BNP SG

NOM JPM BoA ML CA CIB

Swap Market Final

0,0%

0,5%

1,0%

1,5%

2,0%

2,5%

3,0%

3,5%

4,0%

Dec

-12

Mar

-13

Jun-

13

Sep

-13

Dec

-13

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

Jun-

15

Sep

-15

Dec

-15

Mar

-16

Jun-

16

Sep

-16

Dec

-16

Mar

-17

Jun-

17

Sep

-17

Dec

-17

Mar

-18

Jun-

18

UK RPI Inflation (% YoY)

SG BARX DBBNPP NOM JPMBoA ML Swap Market Final

Why is the market so sensitive to inflation?

7

Realised inflation is the main driver of inflation expectations

Because inflation has disappointed for a long period of time now, market participants have become more sensitive to inflation itself.

Source: AXA IM, Bloomberg as at 31/08/2016 – for illustrative purpose only. Developments of the past offer no guarantee and are no indicator for any future returns

or trends.

We expect inflation breakevens performance to track realised inflation.

-3

-2

-1

0

1

2

3

4

5

6

80

85

90

95

100

105

110

Dec-

06

Dec-

07

Dec-

08

Dec-

09

Dec-

10

Dec-

11

Dec-

12

Dec-

13

Dec-

14

Dec-

15

Dec-

16

USA

: Hea

dlin

e CP

I (%

)

TIPS

Cum

ulat

ive

Out

perf

orm

ance

v/

Trea

surie

s (r

ebas

ed 1

00)

US Inflation Drives TIPS Outperformance

USA: TIPS Excess Return v/ US Treasuries (Left Scale)

USA: Headline CPI (%, Right Scale)

USA: Inflation Forecasts (Deutsche Bank)

-3

-2

-1

0

1

2

3

4

5

6

80

85

90

95

100

105

110

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Dec

-17

USA

: Hea

dlin

e CP

I

TIPS

Cum

ulat

ive

Out

perf

orm

ance

v/

Trea

surie

s

US Inflation Drives TIPS Outperformance

USA: TIPS Excess Return v/ US Treasuries (Left Scale)USA: Headline CPI (%, Right Scale)USA: Inflation Forecasts (Deutsche Bank)

-2

-1

0

1

2

3

4

5

6

75

80

85

90

95

100

105

110

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Dec

-17

Euro

Are

a H

eadl

ine

Infla

tion

(%)

Euro

Lin

kers

Cum

ulat

ive

Out

perf

orm

ance

to N

omin

als

Euro Linkers outperformance to nominals compared to inflation

Euro ILB Outperformance to nominals

Euro HICPxEuro HICPx Forecast (Deutsche Bank)

How can we capture inflation?

8

Inflation rate and price index compared

US Headline and Core Inflation (annual rate and cumulative change)

Source: AXA IM, Bloomberg, as at 31/08/2016 – for illustrative purposes only. Developments of the past offer no guarantee and are no indicator for any future returns

or trends.

We expect inflation to accelerate and to remain close to Central Banks targets over the medium term

A close to 2% annual inflation since the year 2000 in the US means that the price index has increased more than 40% since then

This suggests to us that in a low yield world, inflation indexing is attractive

We also believe that duration should be kept under check in such strategies

Income generation is quite similar across the curve…

because the inflation rate paid out to investors is the same across all maturities!

…the difference is the result of long-end real yields being higher than short-end ones.

Given current low yields environment the buffer against rising yields provided by long maturities is lower than in the past.

Short duration inflation-linked bonds

9

Whatever the maturity, inflation indexation remains the same…

Source: AXA IM, Barclays as at 31/08/2016 – for illustrative purposes only. Developments of the past offer no guarantee and are no

indicator for any future returns or trends.

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2010 2011 2012 2013 2014 2015

%

US TIPS Annual Income

All Mat TIPS Income 1-5Y TIPS Income

Inflation-linked bonds

10

Short-end inflation-linked bonds are the most sensitive to oil price developments

Short-end inflation-linked bonds are the most sensitive to oil.

As you extend the maturity of your inflation-linked bond holdings on the curve, the risk morphs from being very sensitive to oil and inflation into a more ‘bond-like’ instrument.

Across markets, US TIPS are the most sensitive to oil prices.

This is because US inflation itself is the most sensitive to developments in the oil market.

Ultra-long UK linkers are less correlated to rates than you may think.

This is because local pension funds are very active in the 30-year and longer maturities.

Source: Bloomberg, AXA IM, Barclays as at 31/08/2015 – for illustrative purposes only. Developments of the past offer no guarantee

and are no indicator for any future returns or trends.

1-3Y3-5Y

7-10Y

10-15Y15-25Y25+ Y

1-3Y

3-5Y

5-7Y

7-10Y

10-15Y15+ Y

1-3Y

3-5Y

5-7Y7-10Y10-15Y

15+ Y

-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

0.00 0.20 0.40 0.60 0.80 1.00

Corr

elat

ion

to O

il

Correlation to 10-Year Nominal Rate

Inflation Linked Bonds Correlation to Oil & Nominal

Bonds

UK US OAT

Higher the duration = more sensitive to interest rates; shorter durations = less sensitive to oil prices

Short duration inflation-linked bonds

11

Short duration inflation-linked bonds performance is historically close to inflation itself.

Performance and inflation



Inflation-linked bonds

12

Real Yield Focus

Real yields are the premium that investors can lock on top of realised inflation

Real yields are correlated to nominal yields but less so for short duration inflation-linked bonds that are more influenced by oil prices than general duration developments.

Investors should aim at maximising their real yields under the constraint of duration.

Current market conditions should favour short duration inflation-linked bonds

We believe that current 1-5 years real yields are higher due to lower oil prices and that the situation should normalise with inflation rebounding during 2016.



-2,0

-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5

2,0

Ave

rage

Rea

l Yie

ld (

%)

Average Real Yields

World Govt Inflation-Linked All Maturities

World Govt Inflation-Linked 1-5Yrs

Timing is good for inflation-linked bonds

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The figures provided relate to previous months or years and past performance is not a reliable indicator as to future performance.

The graphs are given for illustrative purposes.

Information contained in this document may be updated from time to time. Information contained herein may vary from previous or future published versions of this document.

AXA IM UK is registered in England and Wales No. 01431068. Registered office: 7 Newgate Street, London, EC1A 7NX. AXA IM UK is authorised and regulated by the Financial Conduct Authority (No. 119368). Administration office: PO Box 10908, Chelmsford, CM99 2UT. Tel: 0845 777 5511 Fax: 0844 620 0151. Telephone calls may be recorded or monitored for quality assurance purposes.

Editor : AXA INVESTMENT MANAGERS PARIS, a company incorporated under the laws of France, having its registered office located at Majunga 6, Place de la Pyramide 92800 Puteaux, FRANCE, registered with the Nanterre Trade and Companies Register under number 353 534 506, a Portfolio Management Company, holder of AMF approval no. GP 92008, issued on 7 April 1992.

20808 09/2016

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