(Bloomberg Opinion) -- For those following 2020 market outlooks, the past two days have been dominated by BlackRock Inc. The world’s largest money manager began unveiling its calls for the coming year on Monday, and on Tuesday it added TV appearances and journalist discussions with its most senior investors and strategists around the globe.
The broadest takeaway is that 2019’s “extraordinary returns” across asset classes won’t continue over the next 12 months. That’s not particularly riveting, though, given that BlackRock itself said in 2016 that investors should expect smaller gains for pretty much everything in the coming five years. In 2017, Bill Gross made a similar call. And around this time last year, Ray Dalio, founder of Bridgewater Associates and recent mentor to hip-hop entrepreneur Sean “Diddy” Combs, argued investors “need to prepare for lower expected returns in the future.” After the longest expansion in U.S. history, it’s a fairly safe call to make.
A bolder call from the money manager: Inflation poses the biggest risk in 2020 — or, at least, it’s what investors don’t seem to have on their radar. Here’s how BlackRock Vice Chairman Philipp Hildebrand explained it on Bloomberg TV:
“The market is not expecting anything around inflation, basically, and I suspect that when we see each other a year from now, look back at this, we will say ‘wow, inflation actually was a bit more of a story than we thought.’
Again, I don’t think we need to worry. I don’t want in any way to paint the picture of dramatic inflation, but I do think when you look at the details, when you look at the employment report, when you look even at the latest European numbers, wage pressures are at peak expansion levels, so I do expect that inflation is one of the underappreciated risks for 2020.”
Hildebrand is a former Swiss National Bank president, so he’s intimately familiar with global central bankers’ inability to stoke price growth in the wake of the global financial crisis. Critics might dismiss the outlook for relying on the Phillips Curve and other assumptions that don’t truly stand up to scrutiny in this economy. Just last week, University of Michigan survey data showed Americans expect prices to rise by just 2.3% annually over the next five to 10 years, matching the lowest level on record.
The thing is, BlackRock is hardly alone in thinking 2020 might finally be the year inflation stages a comeback. And the advice is simple: Buy Treasury Inflation-Protected Securities.
Bank of New York Mellon Corp.’s 2020 macro outlook is titled “Inflation Insurance Is Underrated.” Bank of America Corp.’s best technical trade for next year is to buy U.S. 10-year TIPS breakevens. Even Steven Major at HSBC Holdings Plc, who has one of the lowest year-end 2020 forecasts for 10-year U.S. yields, at 1.5%, said TIPS appear “underappreciated” and “offer attractive diversification properties.”
Citigroup Inc. strategists went so far as to raise the specter of stagflation: “We see some upside risks to inflation. If these materialize against a weaker growth backdrop, it would be a bad combination for risk assets.” BlackRock, too, is pondering whether the push toward de-globalization will push prices higher because of supply shocks while economic growth slows. It lists stagflation as a “potential regime shift” from the current one, dubbed “slowdown.”
Now, betting on higher-than-expected inflation isn’t as cheap as it was two months ago. The 10-year breakeven rate dipped to 1.47 percentage points on Oct. 8, the lowest in more than three years. It has climbed to 1.7 percentage points since then. The measure reflects the difference between yields for nominal and inflation-linked bonds. When it’s low, it indicates traders don’t see much reason to shield themselves from accelerating price growth over the next decade. The recent peak was 2.2 percentage points in May 2018.
This talk about reviving inflation happens to coincide with the recent death of Paul Volcker, the former Federal Reserve chairman who famously tamed double-digit price growth. As David Beckworth, a former economist at the Treasury Department, noted on Twitter, spiraling inflation was viewed by some Americans in the 1970s and early 1980s as the most important issue facing the country.
That context is crucial because it’s unclear what a meaningful bump higher in inflation would mean to a general public that hasn’t seen the core consumer price index at 2.5% in more than a decade, or at 3% since the mid-1990s (it peaked at 13.6% in 1980). Would it rattle the American consumer’s seemingly unshakable confidence? Or is this just more of Wall Street and the Fed getting worked up over tenths of percentage points in a measure that some consider detached from reality anyway?
Crucially, the Fed appears willing to tolerate higher inflation in something of a “make-up strategy” after years of undershooting 2%. Typically, stocks and other risky assets might balk at quicker price growth on bets that the central bank would raise interest rates. But it’s difficult to even fathom what sort of conditions would make Chair Jerome Powell and his colleagues consider increasing the fed funds rate again after reducing it three times in as many months. That means inflation in 2020 might not produce the usual chain reaction.
Even if the inflation rebound story isn’t persuasive, consider this: TIPS are on pace to top Treasuries again in 2019, which would be the third year in the past four that the inflation-linked securities outperformed. They may not be the sexiest investment out there, but in BlackRock’s eyes, TIPS are for winners.
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Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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