Investors should invest in inflation-linked and longer-dated American government bonds to hedge against a “nasty” correction in emerging markets, the global bond managers at Thames River Capital warn.
Peter Geike-Cobb and Paul Thursby say markets have shifted from pricing in deflation to inflation and are favouring risky assets.
However, they say “a nasty correction” could hit emerging economies, with inflation slowing future growth.
The managers say the risk of a policy mistake in emerging markets is increasing given significant and destabilising inflows of capital.
As a result, they have cut back on risky positions. Instead, they have invested in long-dated American government bonds, whose prices are undistorted by Federal Reserve purchases through the quantitative easing programme. (article continues below)
The managers say the bonds’ prices reflect future inflation in America. However, they have invested in inflation-protected American government debt to protect against higher inflation than expected.
Elsewhere, the managers are pessimistic about government bonds.
They say European bond holders will be repaid at a discount because of the crisis in the eurozone.
Britain will raise rates to fight inflation, which will make low yields on its debt less competitive, they maintain, while Japan will continue to struggle with its gigantic debt burden.