Bonds RouteMap: Rate of Inflation

Buy when the yellow line turns upwards, sell when it turns down

Sample of chart showing correlation between bond prices and inflation (left scale inverted). Forecast year on year changes shown in orange.

This strategy shows how bond prices react to their most important determinant, changes in the rate of inflation. The difference between actual and Fair Value PE ratios after both EPS and the rate of inflation have been cyclically-adjusted by smoothing out over a typical economic cycle. The underlying valuation series is also shown in Momentum & Value charts.
 
For comparability, bond market indices have been rebased to set year-end 1994 at 100. Please note the differences between charts in the Bonds RouteMap and those for other RouteMaps. Since income is a major consideration for investment in bonds, bond market indices are shown as total return and not in terms of price only.
 
The bond price index is shown as the thick white line on the right hand axis. The explanatory variable, the rate of inflation uses the left hand axis, shown as the thin yellow line.  A Best Guess as to the future trend of inflation is also shown on the left hand axis as the thin orange line.
 
The left hand axis is inverted for clarity in showing the close relationship between inflation and long-term bond prices. Thus, a decline in the rate of inflation appears as a rising line that generally moving in the same direction as bond prices. Given that the bond market tends to discount inflation data when released, the main focus of attention is on the forecast period ahead.
 
Owing to the conversion of legacy currencies into Euros, analysis is provided on a common bond market denominated in Euros, rather than for individual countries. Historical data is provided by creating synthetic GDP-weighted time-series for the component currencies, expressed in the European Currency Unit.
 
The Best Guess shows the forecast rate of inflation for the current and following years. The base level is the average for the last completed calendar year. Forecasts are only as good as the Consensus Estimates on which they are based.