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Global Inflation Strategy Summary

Core Content

This document outlines the UBS Global Inflation Strategy, focusing on inflation expectations, real rate dynamics, and trade recommendations for TIPS (Treasury Inflation-Protected Securities), Euro Area Linkers, and UK Linkers. It provides insights into the current state of inflation, the sustainability of real rates, and market outlooks for the coming months.

Main Points

Inflation and Real Rates Outlook

• Real Rates May Be Unsustainable: High real rates are seen as a potential risk to risk assets and US debt sustainability. If inflation moderates or real rates remain high, the Fed may face pressure.
• Bullish TIPS Breakevens: The document remains positive about TIPS breakevens, suggesting they could attract new interest if inflation pressures ease.
• Breakeven Dynamics: TIPS breakevens are currently at the top of their range, but a softening carry season may allow returns without relying solely on breakeven changes.
• Inflation Sentiment: The inflation sentiment scorecard indicates mixed signals across regions and asset classes, with some indicators showing a decline in inflationary pressures.

Trade Recommendations

• US: Long 10y TIPS, long 5y TIPS beta-weighted, and long 2y real rates.
• Euro Area: Neutral on breakevens, long real rates at the front end, and short 5y5y or 10y HICPx.
• UK: Steeper RPI breakevens, long 10y20y RPI vs 30y US CPI, and long 5y5y vs 10y20y RPI.

Key Risk Factors

• Fiscal and Supply Pressures: High real rates may be due to fiscal and supply constraints, which could impact asset returns.
• Carry Season Dynamics: The carry season is expected to soften and turn in March, which could affect returns.
• Market Volatility: High market volatility, thin liquidity, and economic dislocation may affect valuations.
• Geopolitical Events and Policy Shocks: These can introduce additional risks to the markets.

Key Information

• Inflation Trajectory: The document suggests that inflation may fall in coming months, which could lead to a correction in RPI breakevens.
• Market Implied Paths: Figures show market-implied inflation paths, with the UK RPI expected to rise to near 5% by late 2025.
• Interest Rate Risk: The Fed's target rate and real rate dynamics are closely monitored, with the 10y TIPS breakeven hugging the Fed target.
• Economic Indicators: The ECB's inflation indicators have not improved significantly in the past year, and pipeline pressures have bottomed in 2023.

Summary Table of Trade Ideas

Risk and Valuation

• Risks: Multi-asset investing involves market, credit, interest rate, and foreign exchange risks. Correlations may deviate from historical patterns.
• Valuation Method: UBS provides valuations based on various methodologies, including z-scores and fitted treasury curves.
• Disclosure: UBS AG London Branch is responsible for this document. The views may change and are current as of 17 January 2025. Research is subject to policies and procedures, and recommendations are based on independent analysis.

Conclusion

The document suggests a cautious approach to inflation-linked instruments, highlighting the potential for real rates to fall if inflation moderates. It recommends long positions in TIPS and certain inflation-linked instruments while advising against long positions in some Euro Area and UK linkers. The analysis is based on market data and economic indicators, with a focus on the sustainability of real rates and the potential impact of geopolitical and policy events.