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Global Inflation Update Summary: Latest Views and Trades

Core Content Overview

This report provides an analysis of global inflation trends and investment opportunities across the US, Europe, UK, and Japan, focusing on breakeven rates, real yields, and trade strategies.

Global Inflation Trends and Opportunities

US

• Inflation Outlook: Core inflation is expected to rise to 2.5% in 2019, with headline CPI volatile.
• Real Yields: 5y TIPS real yields are at their highest since 2009, with breakevens at a year-to-date low.
• Breakeven Valuation: 7y TIPS breakevens are 25bp too low relative to nominal yields, energy prices, and USD carry.
• Trade Idea: Consider long TIPS Jan-26 breakeven with a target of 220bp, stop at 192bp, and carry of +1bp/month.

Europe

• Inflation Outlook: Eurozone core inflation is expected to rise, starting with October's data, reaching 1.4% by late 2018 and continuing to rise in 2019.
• Growth Outlook: Q3 slowdown is a soft patch; growth is expected to recover to 1.9% in 2018 and 1.5% in 2019.
• Monetary Policy: ECB is expected to end net asset purchases in December, maintaining low real policy rates.
• Trade Idea: Consider long OATei-27 breakeven with entry at 1.46%, target at 1.70%, stop at 1.36%, and carry of +3.7/+4.2/+3.3bp over 1/2/3 months.

UK

• Inflation Outlook: UK inflation expectations are overvalued, with 5y RPI overvalued by 13bp.
• Breakeven Trend: UK BEI is expected to trend downward, especially at the front end, as inflation falls back to BoE target.
• Breakeven Carry: Positive carry for short UK inflation positions, offering protection in case of a hard Brexit.
• Trade Idea: Consider short UKTi-22 vs BUNDei-23 breakeven at 184bp, target at 164bp, stop at 194bp, and carry of +18.4/+27.4/+33.6bp over 1/2/3 months.

Japan

• Inflation Outlook: Core CPI is expected to remain around 0.9% in 2018 and 2019, with a 1% rise from the VAT hike in October 2019.
• Labour Market: Japanese companies are hesitant to raise base wages due to fixed cost concerns.
• Breakeven Valuation: 10y JGBi breakevens have cheapened to 40bp, which is considered cheap relative to current inflation.
• Trade Idea: Consider long JGBi-23 outright at a real yield of -0.32% (or reference breakeven at 40bp), with a target of +10bp profit and a stop at -5bp loss. Carry is +3bp over 3 months.

Key Points

• TIPS Valuation: The sharp correction in TIPS since September suggests they are undervalued, making them an attractive trade.
• EUR Inflation: EUR breakevens are pricing in a typical seasonal path, but the recent dip suggests a buying opportunity.
• UK Inflation: The richness in UK inflation is seen as overvalued, especially with Brexit uncertainty, and shorting UK vs EUR inflation is recommended.
• JPY Inflation: The VAT hike in October 2019 is a major factor, but its impact is expected to be limited due to exemptions and other offsetting factors.

Summary of Trade Ideas

Risks and Considerations

• US: Sustained real wage inflation or PCE above 2.5% could extend the Fed rate hike cycle.
• EUR: Political risks in Italy, stock market volatility, and oil price drops could affect the strategy.
• UK: Brexit uncertainty remains a key risk, though carry is now positive for short positions.
• JPY: The impact of the VAT hike may be delayed or offset by the free preschool plan.

Important Disclosures

• This document is not investment research for the purposes of MiFID II.
• It is a marketing communication and intended for Professional Clients and Eligible Counterparties.
• The content may contain "Research" as defined under MiFID II unbundling rules.
• It is not subject to any prohibition on dealing ahead of the dissemination of investment research.
• The information and opinions are based on public sources and are not guaranteed for accuracy or completeness.
• No liability is accepted for any loss arising from reliance on this document.
• All estimates and opinions are as of the date of the document and are not intended to be updated.