Inflation: Lower for the Duration?

Mid Week Bond Update

Inflation: Lower for the Duration?

Inflation is famously difficult to measure – and could very well be lower than some may assume – a potential benefit for investors with longer-than-benchmark duration.

Inflation expectations have a direct impact on fixed income valuations, both in the short and long run. But this all-important measure is famously difficult to measure – and could very well be lower than some may assume. That, in turn, could mean a benefit for investors with longer-than-benchmark duration.


Four Measures of U.S. Inflation, 2015 – 2018

Source: Bloomberg, June 18, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


U.S. core Consumer Price Index (CPI) inflation, annualized and seasonally-adjusted by the Bureau of Labor Statistics, rose above the Fed’s well-known 2% inflation rate in March 2018, and came in at an annualized 2.2% rate for May. Core CPI has given the FOMC some statistical backup for its stated inclination to hike rates twice in the remainder of 2018. However, there’s still the potential for distortion introduced by corrections for seasonal factors and the effect of “roll-off” of previous years’ monthly figures.

But CPI isn’t the only measure. Two of the Fed’s favored indicators don’t quite line up with it, or each other. The PCE Deflator, at 1.80%, is still below the FOMC’s 2% guideline. The market-based 5-year breakeven inflation rate shows 2.14% -- although some read this figure as reflecting inflation expectations for five years from now.  

A lower inflation rate, of course, suggests current levels of yield, especially at the longer end of the curve, represent better value than many assume. Which, in turn, could suggest that holding more net duration could be advantageous, even if counter to consensus.

On the Rise: Trade-related uncertainty

Current trade conflicts centered around U.S. and China have been felt more deeply in the equity and commodity markets than in fixed income. The uncertainty in stocks has been company-specific as the dollar-value of the threats has risen by a factor of four or more over the past few days. For agricultural commodities, where futures contracts are used as hedging tools by growers planning next season’s crops, the short-term impact has been severe. November soybean futures traded at $911.5 per contract, down 13.5% from their highs on April 12.

The rapidly-ramping dispute may have been a contributing factor for the U.S. 10-year Treasury staying solidly below the closely-watched 3.0% level over the past week even after an intra-day downdraft apparently driven by the news cycle, the 10-year traded at 2.889%, well below its 3.007% spike on June 13th.

On the Slide: Theresa May’s Political Power

Brexit negotiations have reached back into UK politics; the issue of parliamentary approval of the not-yet-settled terms of an agreement now threaten the viability of Prime Minister May’s government. Not only might a vote in Commons result in her ouster, but the result could replace the Tories with a Remain-friendly Labour majority – making negotiations between the EU and the UK even more complex than they are already. This latest bout has shown up in the currency markets; the British pound is trading at $1.3186, down from its intra-day high of $1.3441 on June 14, four days before; UK gilts are trading at a yield of 1.29%, down from 1.39% on June 14th.


All data Source: Bloomberg, June 20 2018 10:00 AM EDT unless otherwise specified.


Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

All Investors in EU and EEA countries ex UK and Switzerland:

Prior to 29 March 2019, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London, EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorised and regulated by the UK Financial Conduct Authority. Subject to regulatory approval as of 29 March 2019, this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6,, Number One, Ballsbridge, 126 Pembroke Road, Dublin 4. DO4 EP27.  Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Investors in Switzerland:

Issued and approved by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:

Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444