Whoever positions first benefits in the face of inflation! Global bond funds rush to buy Australian and German government bonds, with the Federal Reserve and Bank of England labeled as "followers"

According to Zhitong Finance APP, countries that acted swiftly in response to this year's surge in inflation are now winning favor among bond investors, while those who moved slowly may ultimately pay the price with higher interest rates. Asset management firms such as Jupiter Asset Management and Candriam have been buying Australian government bonds, betting that the four rate hikes since February signal the current tightening cycle is nearing its end. UBS Asset Management and France’s Carmignac Gestion SA have been absorbing German bunds, expecting that with the European Central Bank (ECB) taking a more proactive stance—and having greater capacity than the Federal Reserve and the Bank of England to curb inflation pressures—German bond yields will fall.

The logic is: central banks that act earlier will see the effects earlier, thus limiting the extent of further tightening needed. Unlike the previous inflation shock in 2021 and 2022, when central banks maintained a wait-and-see approach before collectively tightening policy significantly, the response this year has been staggered. This creates opportunities for investors to bet on different trajectories.

“Everything this year revolves around inflation and central bank credibility,” said Mark Nash, Fixed Income Fund Manager at Jupiter Asset Management. “Those who make the right call will benefit.”

There are lags in the transmission of monetary policy, so the ECB’s tightening has not yet fully filtered through to the real economy, which also explains why inflation in Europe remains elevated. Reserve Bank of Australia Governor Michele Bullock noted this on Tuesday, pointing out that it may take 12 to 18 months for rate hikes to be fully effective.

The ECB’s stance is a key reason why Carmignac is buying five-year German bonds—as opposed to other developed-market bonds, it prefers bunds. In recent months, the German yield curve has flattened more than those of other countries, exceeding the degree of flattening seen in other G-10 nations, signaling cooling inflation expectations ahead.

“I separate central banks, with the ECB on one side and the Fed and Bank of Japan on the other,” said Guillaume Rigeade, Co-Head of Fixed Income at the French asset management company. “The ECB was very clear around March and April, when they said, ‘OK, this is an inflation shock.’”

ECB President Christine Lagarde said this week that rising bond yields will slow growth and will have a greater-than-anticipated effect in dampening inflation from high energy costs compared to last month’s projections—the central bank raised rates for the second time since June last month. Policymakers need to anticipate secondary effects as early as possible, “because by the time they appear, it’s already a bit too late.”

Kevin Zhao from UBS Asset Management has been buying 30-year German bunds and Australian government bonds, based on the view that central banks that began hiking rates earlier will need less tightening in the future. Meanwhile, he is shorting US Treasuries, expecting that the AI-driven boost to the US economy will require the Federal Reserve to implement further rate hikes.

“During a supply shock, an active central bank is favorable for bond investment because it reduces the risk of inflation getting out of control,” Kevin Zhao said.

With this week’s hike, the Reserve Bank of Australia became the first major central bank to push rates above their pandemic-era peak. Australian government bonds rallied after Bullock said she hoped the four hikes this year would be enough to tame inflation.

Nash of Jupiter Asset Management has overweighted Australian government bonds in all his fixed income portfolios, and this week cut back on flattening-curve positions, switching instead to two-year bonds—after the Reserve Bank of Australia hinted it was nearing the end of its tightening cycle. He has remained cautious about buying Treasuries, believing the Fed is “slow” to follow the moves of Australia and Europe. Nevertheless, this month's bond selloff pushed the yield on two-year US Treasuries to their highest in over two years, prompting him to buy, arguing that markets are overpricing the pace of future hikes over the next few months.

Jamie Niven, Senior Fixed Income Portfolio Manager at Candriam, prefers Australian government bonds over New Zealand and US bonds. He has also reduced exposure to UK gilts, reasoning that the Bank of England, which has yet to hike rates, will have to play catch-up.