Bonds in a time of inflation

We can position the portfolio to benefit from the steepening of yield curves that would result if central banks are seen not to be responding sufficiently to elevated inflation readings. If the market starts to demand a bigger premium for owning long-dated bonds, we would expect the yield ‘spread’ between long-maturity bonds to widen relative to short tenors – for the yield curve to steepen. 

The spread between 50-year and 10-year gilt yields is negligible. We think mounting short-term liabilities and the end of QE will likely see the yield curve steepening in the UK.

A ‘steepening’ bias is currently evident in our positions, particularly in the UK. As we move towards the end of QE in the UK, the long end of the curve is particularly exposed to the higher yields that would result. 

3. Diverging outcomes on inflation give us opportunities to implement cross-market positions.

Third in our relative-value toolkit are our cross-market positions. As the world recovers from the pandemic over the coming years, we expect to see a significant divergence in the trajectories being taken by individual economies. Differences in the size and the composition of fiscal support offered by different governments, and the varied sector exposure of their economies, will result in economies recovering at different paces – and so produce different outcomes for inflation. 

In simple terms, we want long exposure to bonds of those economies where inflation and interest rates will remain subdued relative to those in which inflationary pressures are likely to lead to higher bond yields. 

Today, we are long Germany versus the US. If there is one economy that could be exposed to elevated inflationary pressures that might demand a more forceful response by central banks, it would seem to be the US. While inflation in Germany could well run above the European Central Bank's target for some time, the same is not likely to be the case for many other Eurozone economies – so the ECB will not need to be quite as hawkish as the Fed.

Performance of the Artemis Target Return Bond Fund, from launch to November 30 2021

All figures show total returns with dividends and/or income reinvested, net of all charges. Performance does not take account of any costs incurred when investors buy or sell the fund. Returns may vary as a result of currency fluctuations if the investor's currency is different to that of the class. 

Juan Valenzuela co-manages the Artemis Target Return Bond Fund alongside Stephen Snowden

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