Ukraine crisis-led gas price surge revives demand for
inflation hedges
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[February 28, 2022] By
Yoruk Bahceli
(Reuters) - Market-based inflation gauges
are flashing red as the war in Ukraine threatens to exacerbate already
high energy prices, pushing investors to seek protection in the
inflation-linked bonds they had dumped since January.
Energy supply concerns fanned by Russia's invasion of Ukraine lifted
Brent crude above $105 a barrel and European gas prices have risen
50%-60% since the start of last week.
While safe-haven demand has benefited government bonds, soaring energy
prices have driven bigger gains on European and U.S. inflation-linked
debt, securities whose face value and interest payments rise in line
with inflation.
"UK inflation has been very bid at the front end and that's really just
reflective of the front contract on the natural gas," said Paul Rayner,
head of alpha strategies at Royal London Asset Management.
Yields on British one-year inflation-linked bonds -- or linkers as they
are known -- have fallen 80 basis points since the start of last week,
touching a record low below -7% and at one point implying an inflation
rate over 9%.
Bond yields move inversely with prices.
Before the war in Ukraine, the Bank of England had forecast that
inflation would peak at a 30-year high of around 7.25% in April when a
54% rise in regulated household energy bills takes effect.
A related graphic: UK inflation-linked gilt and gas price:
https://fingfx.thomsonreuters.com/
gfx/mkt/gkplgaxodvb/uk%20linker%20and%20gas%20price.png
In Germany, the biggest consumer of Russian gas, the two-year
inflation-adjusted yield -- which strips out anticipated inflation --
fell 60 basis points since the start of last week and implied an
inflation rate as high as 3.7%, compared to 2.4% at the start of
February.
U.S. moves are smaller, with yields on one-year Treasury Inflation
Protected Securities (TIPS) down around 20 bps.
Those declines partly reverse a surge seen from the start of the year,
when expectations of significantly tighter central bank policy fuelled a
linker selloff and U.S. and German 10-year real yields had risen 70 bps
and 40 bps respectively by early February..
[to top of second column] |
An employee in branded jacket walks past a part of Gazprom's Power
Of Siberia gas pipeline at the Atamanskaya compressor station
outside the far eastern town of Svobodny, in Amur region, Russia
November 29, 2019. REUTERS/Maxim Shemetov.
During the week through Feb. 23, TIPS received their first inflows in five
weeks, BofA said, citing EPFR data.
Many caution that inflation rates implied by linkers are distorted by factors
such as liquidity, central bank purchases and in Britain, huge pension fund
demand.
But energy prices clearly risk aggravating record high inflation; Deutsche Bank
estimates gas prices rising 50% and oil prices 20% would push European Union
inflation to 5.7% in 2022, a percentage point above forecasts without a
Russia-Ukraine conflict.
Growth would slow to 2.8%, well below the 4% predicted by the European
Commission for 2022.
The European Central Bank's chief economist has also told policymakers the
conflict may reduce output by 0.3%-0.4% in a "middle scenario".
"(Stagflation) has become clearly more likely," said Patrick Krizan, senior
economist at Allianz in Munich.
That fear of a growth hit could slow central banks' turn towards tighter
post-pandemic monetary policy. The Bank of England might pare its next rate
hike, while the ECB may delay making firm promises.
"What's interesting in inflation-linked bonds... is you get exposure to the
inflation risk and at the same time it's almost a safe-haven asset, so I think
it makes it doubly attractive," Krizan at Allianz said.
A related graphic: German, UK breakevens:
https://fingfx.thomsonreuters.com/
gfx/mkt/zdpxokrzqvx/uk%20germany%20breakeven.png
(Reporting by Yoruk Bahceli; editing by Sujata Rao and Emelia Sithole-Matarise)
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