Description: Konstantin Boehmer appears onscreen next to a view of his presentation slides. 

Konstantin: So, let's take a look at the tips and our inflation views, because inflation is the hot topic in financial markets. 

Description: A slide appears showing U.S. inflation data. The slide shows that headline and core inflation dropped massively in the first quarter of 2020, from about 2.5% and 2.3% respectively, due to the pandemic-related shock on global demand, showing slow signs of recovery in the second and third quarter. 

Konstantin: And today was actually a good example for it, we have had blockbuster retail sales, we had lots of other economic data which came out, which was phenomenal, but the market is kind of overlooking those economic data because it is not on the radar for the Fed, nor should it be then also for investment professionals like us. 

Yes, it's great to get good economic data, but that's kind of baked in, and it was also somewhat expected. If you hand out $100 checks to people in the US, there is an expectation that this will translate into higher retail sales. So, there's expectation that economic data will improve also with the reopening of the economy and the phenomenal rollout of the vaccines, so that means that economic data is a little bit secondary in terms of its importance, because that is already a known, the unknown piece is what happens to inflation. And we've been in a low inflation rate environment for a very long time, but we are possibly at an inception point where we are breaking out of those 2%, slightly under 2% range, because there are quite a few upside pressures in the economy. 

And to name a few, we have unprecedented stimulus from the federal government. We have a massive amount of savings, so the savings rate went through the roof last year. That also means we have a lot of pent-up demand, right? Everyone was locked up in their houses. Once that lock will be lifted, there is a lot of things that people want to do and that they would like to resume, so there's a lot of pent-up demand. Commodity prices are spiking higher, and that is not only in the oil space or copper that are popular to look at, but it's also in food prices. We have multiple supply disruptions in the past. So, there is a lot of pressures underlying in the economy, but at the same time, the arguments against are still there, which is [why] we are in a technological transition, and that is generally keeping the lid on inflation. 

We have still a lot of spare capacity in the economies around the world. That should in general also limit the amount of inflation that can structurally flow through the economy. And probably on top of that, you also have the mindset that we've been with low inflation for a long time, so it is hard for people to believe that we are in an inflationary environment, which is a necessity to see the actual inflation rates go significantly higher. So, I'm personally more in the inflationary camp, and that is also for as long as the Fed is staying on the sideline, for as long as the Fed is saying that inflation is transitory or temporary, those would be the times when I like to own inflation protection funds, because that's allowing for those inflationary pressures to build up in the economy. Once you have the central bank becoming laser-eyed focus on inflation, then probably you would like to shift out of inflationary assets. 

Description: A second slide appears showing U.S. break-even rates for the USGGBE05 Index, USGGBE10 Index and USGGBE30 Index. The slide shows the strong signs of recovery since March 2020 lows amid accommodative central bank policies. A detailed line graph shows that breakeven rates of inflation moved from about 1.8 to 2.3% in January 2014, varying over the years roughly between the 1.5-2% mark until the March 2020 lows, after which they’ve risen to roughly 2014 rates. 

Konstantin: So, the next slide we show tips. So, that has been one major component in many of our funds throughout last year. We have a significant position still in inflationary bonds. So, what we see here is the break-even rate. Break-evens are, if you take a regular bond and you subtract the real yield of the tips, then you're left with what is left over, and that's the break-even. So the higher the break-even rate goes, the more tips are outperforming nominal bonds. So what we see here is that since the lows of the March episode, tips have outperformed significantly nominal bonds, which is also not surprising, because they underperformed on the way down, and because they are treated a little bit more like a risky asset, but they have really accelerated in the last few months. And that is to the one hand the inflationary pressures that I mentioned just a few minutes ago, but on the other hand, it is also the change in Fed mandate where they are allowing for inflation to overshoot on the upside before they start to put their foot on the brake pedal to reign in any inflationary pressures. 

So, that is an environment where we're now in. We have the highest break-evens since quite a long time. So, that is of course something that we also notice, where we have to make judgment calls of whether we are still as bullish on inflation protection as we were a while ago. I still see that there is quite some room to go, and particularly if we see another leg higher in interest rates, tips are generally a good place to hide and get a less volatile experience in that rise in yields. One thing to always also keep in mind, and that relates to inflation, it is easy to push toothpaste out of the tub, but it's very hard to bring it back in. So once we start to see inflation, those things can also spiral very quickly into something that we haven't seen in a very, very, very long time. And most market participants don't even know what inflation means, and I'm included in that cohort when I look at my experience in developed markets, but as a person who's worked also in emerging markets, inflation can come very quickly and can stay for a very long time.