So with real yields now positive, US TIPS look like an attractive risk to take on. In a world full of uncertainty, if you were offered a return above inflation of almost 2% for the next 30 years, with no default or deflation risk, and in a sovereign, dollar denominated asset, wouldn’t you be tempted? We are, and long-dated US bonds are the one asset that has lured us out of cash in recent weeks.
We think inflation is close to peaking, and bond markets could be the first to sniff out a Federal Reserve pause. Adding TIPS also provides the chance to diversify our inflation protection – and to make money should tightening pressures ease. In fact, it’s hard to imagine a scenario in which equities can rally without a move in yields first.
That makes these bonds a two way bet: a money-making opportunity if the Fed does pivot or pause, and an asset that could provide some protection in a recession, when bond yields tend to fall.
But hold on, discussing peak inflation feels like a big moment for a strategy which is synonymous with concerns of higher inflation…
Well, our view remains that we are firmly in a new structural regime of inflation volatility, and the recent actions of governments and central banks have only reinforced this view. However, shorter term, we can foresee inflation falling (just not all the way to current central bank targets) and recession risks continuing to rise. As a result, we have positioned the portfolio to navigate an environment where rate hikes will slow or even pause in the next few months. Bonds will help us do that.
Crucially, Ruffer has been here before. At the covid nadir, the severe dislocation in the TIPS market (though only showing as a blip on this chart) gave us an entry point to participate powerfully in the subsequent summer rally, without needing to add to equities. Having preserved capital over the first quarter of 2020, we could take opportunities when others were taking cover. This is the true value of an unbenchmarked, unconstrained strategy: the ability to look at investments through a different lens and find the most appropriate way to add risk in the circumstances.