J.P. Morgan has broken out its playbook for rising inflation after U.S. figures have printed stronger than expected surprising even its economists, who had expected labor costs and broader price gauges to firm this year.
“The playbook for rebalancing portfolios as inflation rises includes short duration, long linkers and selective commodities now, and underweights of risky markets only much later,” J.P. Morgan said in a note on cross-asset portfolios on Friday.
It noted that how disruptive inflation proves for markets will always depend on the asset class and the horizon, with bonds and some commodities reacting first, credit second and equities and emerging markets a “distant third.”
J.P. Morgan said it’s already begun putting its playbook into action.
Since the fourth quarter of last year, it’s been either short duration or in short-duration proxies, such as flatterers in the U.S. and steepeners in Europe and Japan, the note said. It’s also long inflation-linked bonds in the U.S., versus Europe, and long oil and agriculture.
But J.P. Morgan said that it this cycle, “conceptually appropriate” inflation hedges, such as owning base metals, look less appealing amid a slowdown in major commodity market China.
’Gold less consistent’
While gold can also be a strong performer in a mid-to-late cycle transition as inflation rises, it gains less consistently than oil, J.P. Morgan said.
It added that it’s been Underweight U.S. and Euro credit in a multi-asset portfolio, but noted that was due to duration risks as rates rise and not on any profit concerns.
In mid-2018, it advised considering closing oil as a hedge as non-OPEC supply was set to grow.
In early 2019, J.P. Morgan said it expected U.S. Federal Reserve policy would near slightly restrictive levels and it advised considering unwinding most inflation positions and looking at “growth slowdown” trades. That would include owning long duration bonds, underweighting equities and bonds and underweighting cyclical commodities, such as oil and base metals.
Other trades under J.P. Morgan’s heading included underweighting cyclical currencies, such as those tied to commodities or emerging market pairs, while overweighting non-U.S. dollar reserve assets, such as the euro, the yen and gold.