The UK seems rather more sanguine about the prospects of domestic inflation. There is no sign that investors are bailing out of bonds.
UK fixed income flows for the quarter to the end of February 2021 were £5.1bn. The 10-year quarterly average is £3.2bn, so flows are significantly up. This is not the bond bloodbath that many have been expecting. Or, if it is, no one has seen fit to tell fund buyers.
How does this pan out when we look at more granular bond classifications? If investors are hunkering down for a significant uptick in inflation, you would expect to see flows toward inflation-linked bond funds, which would give a measure of inflation protection. And, as illustrated, that is indeed what US investors are doing.
The chart above tells an interesting story. Over four years, flows into bond GBP inflation-linked funds peak in the three months ending May 2017, at £1.37bn. This is at a time when inflation is climbing relatively steeply, to top out in the autumn of 2017 at 2.8 per cent (see chart one).
As UK CPI declines thereafter, flows mute and eventually go negative. Over this period, you have to squint to see US linker flows. They become meaningfully positive as UK inflation continues to trend down, while US inflation stays around the 2 per cent mark. It is also at a point, from late 2018, when former US President Trump got into a public row with the Federal Reserve about raising rates.
So far, so much ancient history. But it does show us that UK investors were behaving rationally in moving their money out of UK linkers while buying US ones as US and UK base and inflation rates diverged.
So, what is happening now? Since the summer, both US and UK linker flows have turned positive, indicating that UK investors expect inflation.
But they are expecting it much more – if these figures tell us anything – from the US (£1.77bn versus £700m for GBP-denominated inflation-linked bonds). The current trend is unusual, as there has been only one three-month period over the past decade that US dollar flows exceeded sterling flows when both were positive. Bond US dollar inflation-linked flows are normally a fraction of their sterling counterparts (remember, we are just talking about UK investors here).
The inference, then, is that UK investors agree with their US counterparts, and expect to see US inflation. They expect it less, or later, in the UK.
