Asset Allocation Video

The Challenge of Rising Inflation
Tim Murray, CFA Capital Markets Strategist, Multi‑Asset Division
Key Insights
  • In a highly inflationary environment, bonds could lose their typical hedging characteristics, posing a challenge for asset allocators.
  • Bank loans may potentially benefit investors seeking a fixed income option with less sensitivity to rising interest rates.

Asset allocators face a challenging environment as inflation expectations continue to rise amid sharply higher commodity prices and rapidly rising wages.

Key Insights
  • In a highly inflationary environment, bonds could lose their typical hedging characteristics, posing a challenge for asset allocators.
  • Bank loans may potentially benefit investors seeking a fixed income option with less sensitivity to rising interest rates.

Asset allocators face a challenging environment as inflation expectations continue to rise amid sharply higher commodity prices and rapidly rising wages. While bonds typically help to provide some downside risk mitigation to a portfolio when stocks decline, stock and bond returns tend to become more correlated in a highly inflationary environment.

To account for this dynamic, the Asset Allocation Committee is overweight to bank loans, as their interest rate reset feature makes them less sensitive to rising rates than traditional bonds. As shown in Figure 1, during the last four periods where the 10-year U.S. Treasury yield increased by more than 1% in less than a year, bank loans posted positive returns and meaningfully outperformed the broader fixed income market.

Investors should note that although these loans offer an appealing alternative, they are vulnerable to credit risk and generally have high yield credit ratings. Fortunately, the current strong economic environment has driven down default rates (see Figure 2). Further, the fundamental outlook for bank loans appears attractive given the anticipated acceleration in growth as economies reopen globally.

Notably, these supportive expectations have—to some extent—already been priced into bank loan valuations, driving yields to below-average levels. However, bank loans still remain relatively attractive compared with other fixed income segments.

While sharply rising inflation may pose challenges for asset allocators, an allocation to bank loans could, in our view, potentially benefit investors seeking a fixed income option with less sensitivity to rising interest rates. 

The Case for Bank Loans

The fundamental outlook for bank loans is attractive

(Fig. 1) Bank Loan Performance When Rates Rise Sharply

Bank Loan Performance When Rates Rise Sharply

(Fig. 2) High Yield Versus Bank Loans, Default Rates

High Yield Versus Bank Loans, Default Rates

Past performance is not a reliable indicator of future performance.

Sources: S&P/LSTA, Bloomberg Barclays. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosures. Bank Loans represented by the S&P/LSTA Performing Loan Index, U.S. Aggregate represented by the Bloomberg Barclays U.S. Aggregate Bond Index. (L)=Left-side axis, (R)= Right-side axis. High yield default rate source: J.P. Morgan Global High Yield Index. Bank loans default rate source: J.P. Morgan Leveraged Loan Index. See Additional Disclosures.

Get the full story.

We’re ready to share our latest thinking, but industry regulations require you to register or sign in to watch.

Just one more step.

To continue, you are required to read and accept our Terms & Conditions. Thank you for understanding.

Additional Disclosures

Financial data and analytics provider FactSet. Copyright 2021 FactSet. All Rights Reserved.

Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval.

Copyright © 2021, J.P. Morgan Chase & Co. All rights reserved.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of June 2021 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc.

© 2021 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/ or apart, trademarks of T. Rowe Price Group, Inc.

Dismiss
Tap to dismiss