VINACHEM

Given that consumer prices have either moved lower or essentially stayed put in the developed world for much of the past year, the word inflation does feel a little strange on the tongue. U.S. consumer prices declined through the 12 months ended in May and have pretty much flatlined since, while Japanese inflation has stayed under 1 percent all year. After falling for four consecutive months, starting in December 2014, European consumer prices have stayed where they are as well. But Credit Suisse believes inflation risks are growing – so much so that investors may want to revisit inflation-linked bonds.

Inflation expectations in the U.S., as measured by the breakeven inflation rate, or the difference between the yield on 10-year Treasury bonds and 10-year Treasury Inflation-Protected Securities (TIPS), were on a steady downward course between early July and late September, but they have picked up again since. Oil prices played a major part in that decline. While they seemed to stabilize in the $60-range in April, they began falling again in July. China concerns began to weigh on inflation expectations the same month, as the country’s stock market crash threatened to exacerbate its ongoing economic slowdown.

While the 10-year US breakeven rate has risen from 1.39 percent on September 29 to 1.55 percent on October 7, Credit Suisse’s Private Banking and Wealth Management’s Investment Committee believes these expectations are too modest compared to the central banks’ inflation targets. In addition, two major weights holding inflation down are starting to lift. Credit Suisse’s energy analysts expect oil prices to stabilize and even begin rising again in 2016, while the Private Banking & Wealth Management (PBWM) division has a relatively upbeat view on China. The bank’s analysts believe that the government’s stimulus measures – lower interest rates, property minimum down-payments, and reduced car taxes among them – will help the economy to stabilize. As it works its way back up to speed, demand for more steel and other metals should give commodity prices a shot in the arm.

The developed markets, where growth has been steady and is expected to remain so, are particularly likely to see inflation pick up in 2016. The quantitative easing measures Europe and Japan have implemented are inherently inflationary, and central banks in the developed world have all made it clear that they hope to push actual inflation levels closer to their target rates. Consumer-led recoveries in both Europe and Japan are on solid footing, while U.S., consumer spending has been strong. Rising home values are also making American households feel wealthier, which should help keep retail cash registers chiming. Credit Suisse’s economists predict that average annual inflation will rise from 0.1 percent in 2015 to 1.9 percent in 2016 in the U.S., from 0.1 percent to 1.0 percent in Europe, from 0.1 percent to 1.2 percent in the United Kingdom. As is often the case, Japan is an exception, with inflation expected to remain steadier at 0.9 percent this year and 1.0 percent next.

With prices marching upward for a change, inflation-linked government bonds suddenly look like a more attractive investment than their nominal cousins. As the name implies, inflation-linked bonds link both the coupon and nominal value of the bond to an inflation index, which preserves value during times of rising inflation. On the other hand, deflation reduces both the coupon and nominal value of the bonds. Since that risk seems to be on its way out, bonds that hold their value in the face of rising prices are likely on their way in.