BNP Paribas SA and Franklin Templeton say real yields will rise in the months ahead, predicting that price pressures will stabilise.
Franklin Templeton’s Mohieddine Kronfol said the money manager is shorting Treasury Inflation-Protected Securities, or TIPS, as it expects the value to decline along with inflation expectations. BNP Paribas favours betting on a rise in the German 10-year real yield to minus 1.7% by year-end from almost minus 2% Thursday, with the European Central Bank set to wind down its emergency bond-buying programme in the fourth quarter.
The biggest question facing policy makers and investors in 2021 is whether inflation will prove a temporary phenomenon. Markets are pondering when the Federal Reserve and its global peers will start to pull back on the massive bond-buying programmes they unleashed during the pandemic last year, against the backdrop of the uneven nature of recovery and ongoing risks from coronavirus variants.
“We fall in the camp where we feel that inflation will be more transitory,” said Franklin Templeton’s Kronfol, Dubai-based chief investment officer for Middle Eastern and North African fixed income. “As we move to more normal operating environment, a lot of these supply bottlenecks and other issues that have been driving inflation will start dissipating.”
The US real yield – the nominal yield on Treasuries minus the rate of inflation – serves as a popular gauge to judge how attractive riskier investments are in relation to Treasuries. It was at minus 1.05% Wednesday, compared with minus 0.5% in February.
Fed Chair Jerome Powell has said that current price pressures represent temporary shocks associated with the reopening of the economy, even as the central bank’s leading hawks urged policy makers to move quickly to slow asset purchases.
Meantime, with the next ECB policy discussion a week away, officials are staking out their diverging positions as inflation in the euro region jumped to 3%, well above the central bank’s goal.  
Nominal yields should climb as the ECB buys fewer bonds and concerns over the delta variant ease, according to BNP strategists Camille de Courcel and Chris Lupoli. But they expect any increase in inflation expectations to be limited, thereby putting real yields in the driving seat for higher borrowing costs.
For Franklin Templeton’s Kronfol, the risk of higher real rates means his Gulf Arab bond fund  – which outperformed 90% of its peers in the past month – has adopted a more defensive stance.
It holds securities with an average credit quality of A- or BBB+. With an elevated cash level of 10%, the fund is also preparing to scoop up assets in any selloff, according to the manager.
“The risk is you can have higher real rates, but we think it’s less likely to come from nominal rates rising aggressively, but rather inflation expectations coming down,” Kronfol said. “Hedges are in place to guard against rising real rates.”