Inflation is finally here, at least according to the bond market. And this may be just the beginning of the trend. Across the world, people are starting to ask that their salaries increase, too.
Even in Germany, where for a decade of strong growth wages have remained constant, workers are going on strike for higher pay -- and fewer hours of work.
In Japan too, employees are beginning to stir and ask for higher pay. Unemployment there is virtually non-existent and the country is reluctant to accept immigrants, so Japanese workers will probably be successful.
In the U.S., with the Trump administration's tax cuts and infrastructure spending working their way through the system, demands for wage increases are likely to be on the menu for a while.
In the U.K., starting salaries have risen to the highest level since before the Brexit vote in June 2016, data from recruitment company Adzuna showed on Friday, Feb. 2. In Britain, the inflation problem is compounded by the fact that the fall in the pound after the referendum has pushed up prices of imported goods.
Exchange rates are indeed something to watch when it comes to inflation. Oil and other commodities are priced in dollars, and because of the dollar's weakness, they will contribute to inflation as well. Even when stripping volatile energy and food prices and looking at core inflation, there will be some pass-through effects.
Bond yields have risen, with the 10-year U.S. Treasury yield currently at around 2.77% -- a level which, according to FactSet data, has not been hit since January 2014. And yet, investors are still not prepared for a reappearance of inflation, Alberto Gallo, portfolio manager at Algebris Investments, said recently.
Unlike in the 2013 and 2015 bond market tantrums, long yields have remained relatively flat, causing little spillover to broader risk markets. This is mainly because expectations of a hawkish Fed have been tempered by the dovish stances of the European Central Bank and Bank of Japan.
"If a return of inflation is the trigger, then investor long positioning is the dynamite," Gallo wrote in research published earlier in the week. He sees an abundance of signs of complacency: retail buying, chasing of market performance, sell-side analysts raising their earnings forecasts, continued selling of volatility premiums.
"Many of these carry strategies depend on a stable and low interest rate environment," he warned.
Gallo has been positioning his firm's portfolio underweight sovereign and corporate bonds since the end of last year, because these "may suffer asymmetric losses in a correction." He has been buying asset classes that could benefit from reflation and increasing geopolitical risks: equities in the energy and financials sectors, as well as emerging markets and commodities stocks.
In the equities space, Europe is not among his favorites, despite the continuing economic recovery. European firms' profits are likely to be capped by the stronger euro in most sectors except for financials.
However, for investors who still need some fixed-income positioning, Gallo believes "Europe remains a better place to hide" from inflation's effects, with the periphery and Greece poised for a reduction in risk and benefiting from a reallocation of global bond investors' portfolios.
With inflation back on the menu, investors should pay more attention to their strategies. The era of easy returns from passive increases in index-tracking funds may be over.