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EV Forward: Short-Duration Inflation Protection

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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By EV Forward

Boston - We seek to deliver inflation protection with less interest-rate risk than is typically found with longer-duration, traditional inflation-protection strategies.

What we are seeing

Despite widely held expectations that inflation might have peaked, the May Consumer Price Index (CPI) indicated that U.S. inflation could likely go higher and be more broad-based than expected. The ongoing Russia-Ukraine war continues to pressure food and energy prices, while renewed COVID lockdowns in China threaten progress made in taming goods inflation and global supply chain constraints.

Consumers' longer-term outlook for inflation also spiked higher, which — combined with a tight labor market — could put further pressure on wages and push inflation higher.

In this inflation cycle, traditional inflation-protection income strategies have generally delivered sharply negative total returns along with the broader fixed income markets. By contrast, shorter-duration, inflation-focused strategies have performed positively.

What we are doing

The strategy was designed precisely for this environment — one in which inflation is high and the Federal Reserve has to raise interest rates quickly to try to contain it. We are still seeking to deliver inflation protection with less interest-rate risk than is typically found with traditional longer-duration, inflation-protection strategies. We believe this is best achieved by:

Focusing on shorter-duration, inflation-linked assets. These are 1) less negatively impacted by rising interest rates, 2) better correlated with the inflation consumers are experiencing, and 3) more likely to provide inflation protection if inflation continues to surprise by overshooting expectations.

Swapping interest rate risk for credit risk. Floating-rate securities, such as bank loans, can potentially enhance total returns and have attractive correlations with inflation. However, we are moderately decreasing this exposure and moving to a more neutral positioning across credit sectors, as the Fed has pivoted to tightening monetary policy more quickly and aggressively than anticipated.

What we are watching

We are keeping a close watch on high-frequency economic data that indicate the direction of the labor market and inflation, which will be key to future central bank policy.

Corporate earnings reports will start to be released in July. We will monitor these, focusing on:

  • Top-line trends to show the adjustment between goods and services
  • Companies' ability to maintain margins and pass through higher costs
  • Corporate hiring plans to get a sense of intermediate-term labor market conditions
  • Capital allocation decisions to learn how management teams are planning to use their balance sheets

We are looking at global central banks and their reaction functions, or how effective the banks' policy tools are proving to be. Consistently, we are tracking market "technicals" around global capital flows to gauge security supply and demand levels.

Jason DesLauriers, CFA
Portfolio Manager

Brian S. Ellis, CFA
Portfolio Manager