The 'Pickle' That Central Banks Are Stuck In & Other Key Points To Citi's Global Inflation Strategy

In a report rolled out Wednesday, a group of 19 analysts at Citi share the firm’s Global Inflation Strategy, assuring “central banks [are] in a pickle.” So, let’s take a quick look at some highlights from the long research note.

US TIPS

While there is not much to say about inflation in the US, the firm notes that long positions in breakevens provide a cheap option on inflation, especially after the plummet they experienced over the past month.

Euro Linkers

Despite the Quantitative Easing, the European Central Bank (ECB) has considerably lost credibility in inflation matters. The market does not expect the 2 percent target to be achieved, even over the very long-term. Thus, Citi remains short 5y5y HICPxT (European Inflation Index, excluding tobacco).

UK Linkers

The firm maintains shorts in 5y5y RPI (Retail Prices Index). In its radar, they include selling 50yr real yields and 10s30s RPI flatteners.

Japan JGBIs

The analysts think the fair level of 10y BEI for Japan stands below 70bp. The note that, “The market may find it difficult to digest next issuance wave of 1trn in nearly two month starting in November.”

Latam Linkers

The experts hold onto their long bias for front end BEs in Mexico. “Politics remains the key for Brazilian assets, with recent signals suggesting deterioration,” leading the firm to expect a weaker currency and more elevated breakevens.

CEEMEA Linkers

Citi expects to see BEs in Turkey move even higher, driven by higher inflation, a central bank that is moving away from a hawkish position and “as the risk appetite for nominal bonds dwindles in a volatile FX environment,” the report explains. “The move higher in South African breakevens in the last month should turn down led by lower commodity prices and limited pass through.”

Global

The analysts look into the evolution of global central bank balance sheets with no new QE programs, and into how FX reserve declines would impact rates. Assuming no new policy measures, the firm estimates that “global central bank balance sheets will peak in August 2016, as ECB QE could terminate along with TLTRO repayments. The Fed and BOE balance sheets are expected to passively decline,” while Citi’s calculations assume that BoJ goes on with the current path of QQE until Mr. Kuroda’s term finished in March of 2018. Ceteris paribus, that would become a headwind for rates markets, which could witness real rates rise, challenging risk assets. The inference is similar when looking at the fall in global reserves.

However, the experts note all else is far from equal. Thus, their expectation is that “the BoJ will expand QQE, possibly sometime between October-2015 and January-2016.” On the ECB, they believe markets can price QE2. Meanwhile, the SNB will probably continue interventions “while the PBOC should provide extra liquidity to offset the capital outflows.”

Euro Economics

Going forward, Citi anticipates that the projected uptrend in core inflation will continue to be limited by the “still-large amount of spare capacity, second-round effects from past euro strength, and a subdued wage outlook.”

UK Economics

A renewed weakness in petrol prices, the disinflationary effects of the strong pound and shy external growth, lead the analysts to forecast 2016 inflation of 1.1 percent YoY.

Japan Economics

The analysts believe that the recent recuperation of the CPI excluding fresh food and energy looks to rely substantially on higher costs, including the impact from the depreciation of the yen.

Commodities

“Crude oil prices are testing new lows for the year and look poised to push lower. Food at home CPI could go even lower through end 2015.”