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The new wedge in US inflation linked bonds

There has long been a well-known ‘wedge’ in the UK index linked bond market, since the bonds pay RPI and the Bank of England targets CPI. The wedge is the difference between these two price indices, and over the long term is thought to be approximately 1%. So over the long term, and with all sorts of caveats, RPI will be around 1% higher than CPI. The reasons for the wedge are essentially that …

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Either longer dated index linked gilts are very vulnerable, or the UK economy is

If at the beginning of 2014 you had made a list of what you thought would be the best performing fixed income asset classes globally for the coming year, it’s very unlikely you’d have put UK index-linked gilts at the top. It’s probably even less likely that you’d have put Argentina’s (hard currency) bond market in second place, especially if you had been told that Argentina would default in 201…

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Falling soft commodity prices are a piece of cake

Higher agricultural commodity prices at the start of the year raised concerns about the impact these could have on retail food prices, should the trend prove persistent. Fortunately, the price of soft commodities (coffee, sugar, wheat etc) appears to have decoupled from that of hard commodities (gold, silver, platinum etc) in recent months. Indeed, data from the last seven quarters indicate tha…

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Judgement Day – RPI Damp Squib

Today has seen the release of the decision by the National Statistician about what to do with the Retail Prices Index. We were told of the consultation in September last year, and were presented with 4 options, ranging from 1) to do nothing, to 4) to make RPI as much like CPI as possible.

Our view was always that the consultation arose as a result of the desire to correct an error made in the c…

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Crazy weather and the butterfly effect on inflation

It seems that the wettest “summer” on record in England is not only playing havoc with the M&G cricket team’s schedule, it is also having a massive impact on the nation’s butterflies. Sir David Attenborough is asking people to participate in the world’s biggest butterfly survey – The Big Butterfly Count – to see how the butterfly population has fared after all the wet weather we have been havin…

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Why the UK has a real rate problem

The financial crisis is resulting in the authorities, the public, and investment managers seeing things they did not expect to see. Today’s headline RPI level of 5.5% is a record 5% above the Bank of England base rate of 0.5%, resulting in a negative real interest rate (base rate – RPI) of -5%. This is the most divergent I’ve seen this in my 25 years in the city (see chart).

The bond bears th…

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Inflation Hedging for Long-Term Investors – the most important academic paper you will read this year

You would have to be living under a rock to not notice the increasing number of articles dedicated to the topic of inflation. The increase in inflationary articles has almost been as dramatic as the increase in inflation itself. Even 3 out of our last 4 blogs have been on inflation. Unsurprising really, seeing as we are bond investors.  Looking elsewhere, the pundits have decided to focus on th…

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Foreign investors still love gilts

After December’s big sell-off in US Treasuries on the back of fears about the US’s creditworthiness, and the surprise at yesterday’s record monthly budget deficit in the UK, there’s been a lot of talk about a bond market “buyers’ strike”.  In particular the western bond markets’ reliance on Asian central banks has made many nervous that a change in risk appetite there could result in strings of…

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UK linkers becoming stinkers

In the recent emergency UK budget it was announced that public sector indexation would change from RPI to CPI from April 2011.  Now, the government is proposing moving private sector schemes and the Pension Protection Fund (PPF) indexation to CPI too.  As Pensions Minister Steve Webb argued, it makes sense switching to CPI as it’s the measure that the BoE targets and (slightly more dubiously) C…

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Not quite a letter – CPI comes in at 3%

CPI inflation in the UK hit 3% in December. Anything higher than this and the Bank’s Governor Mervyn King will have to write a letter to Gordon Brown explaining why inflation is so high. It probably won’t read “Dear Gordon, the reason inflation has busted out of the target you set for us is that we’ve kept real interest rates at exceptionally low levels for too long. Yours, Mervyn.” – but it pr…

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