8 min 16 November 2022

Inflation: taking advantage of second round effects

In our view, second-round effects[1] on inflation are the next challenge for central banks. Already well underway in the United States, they have started to materialize in Europe in recent months. Thus, we believe it will take time for inflation to return to central bank target levels. We remain positive on short inflation-linked bonds in the current environment.

[1] Second-round effects refers to a spiral of price-wage increases, leading to or reinforcing inflation.

The dynamics of price indices continue to fuel second-round effects

In the US, after peaking at 9.1% in June, inflation is finally showing some signs of stabilization, posting levels of 8.2% in September and 7.75% in October.

However, we are convinced that it is premature to claim victory too quickly, as inflation figures have surprised investors over the past year. Indeed, we are seeing a steady increase in the services component of the overall basket (see Figure 1). This component is the most structural and sustainable. It now accounts for half of the inflation basket. U.S. inflation is thus mainly driven by wages and real estate, while pressure on the food component is a persistent upside risk for the coming months.

Evolution des composantes de l'inflation américaine depuis 2019. Source : Bloomberg

Figure 1: Changes in the components of U.S. inflation since 2019. Source: Bloomberg


In Europe, inflation continues to form a high (see Figure 2). The HICP index posted 10.7% in October after 10.1% in September and we expect it to remain above 10% until the end of the year.

Evolution des composantes de l'inflation la zone euro depuis 2018. Source : Bloomberg

Figure 2: Changes in the components of Eurozone inflation since 2018. Source: Bloomberg


Although energy accounts for half of the total inflation experienced in the eurozone, it is undeniable that inflationary pressures are spreading to the rest of the economy.

The food component also rose sharply over the summer as a direct result of the Russian-Ukrainian conflict. While energy and food are perceived as cyclical and transitory, it is the magnitude of the shock and its duration that make us fear a spiral on the more structural components.

Core inflation reached 4.8% in September and should continue to rise above 5% by the end of the year.

Inflation will take time to return to central bank target levels

At Groupama AM, we share the view that inflation will take a turn in 2023 but will take time to reach the central banks’ target level.

The base effects on energy and certain durable goods, particularly in the United States, will naturally reduce overall inflation over the next year. However, we are convinced that this inflationary shock has been sufficiently strong and lasting to cause second-round effects limiting the probability of a rapid return of inflation to the 2% target.

The resilience of the labor market (unemployment at 3.7% in the US and 6.6% in Europe in October), wages and the ability of companies to weather input price increases will be the key variables to watch in order to assess the resilience of the inflationary shock we have been experiencing for the past year.

In the longer term, we confirm our view that the deep transformations that our developed economies will undergo, notably around the environmental transition and the desire for greater strategic autonomy, are elements in favor of structurally higher inflation than what we experienced in the previous cycle.

It is also interesting to note that since 1970, previous episodes of inflationary shocks (above 8%) in developed countries have resulted in at least a two-year period of inflation above 5%, as shown in the bottom of the light blue envelope in the graph below (see Figure 3). When we look at the median, it would take rather 3 years to get back below 5% inflation.


Comportement historique de l'inflation quand elle atteint 8% sur un an.

Figure 3: Historical behavior of inflation when it reaches 8% over one year.
Sources: World Bank, calculations: Groupama AM


Therefore, it seems surprising to us that the market continues to position itself on a rapid return of inflation to the level of central bank targets (2%) in the short term. Thus, according to our 4-to-5-year inflation forecasts, the market is underestimating the levels of inflation that we will encounter (see figure 4).

Anticipations d'inflation aux Etats-Unis et en Europe depuis 2020

Figure 4: Inflation expectations in the US and Europe since 2020.
Sources: Groupama AM, Bloomberg


We remain positive on short maturities inflation-linked bonds in the current environment

As a reminder, inflation-indexed bonds allow an investor to capture a higher return than fixed-rate bonds when actual inflation is higher than market expectations.

Fixed Income assets remain vulnerable to the normalization of central banks, which will not be able to take any risks in the face of inflation. Therefore, we believe it is appropriate to capture this inflation premium, while limiting exposure to duration risk. Moreover, market levels regarding long inflation expectations seem high to us.

Indeed, in both the United States and Europe, 10-year break-even inflation rates are well above the 2% target (see Figure 5) and have been leveling off since the beginning of the central banks’ normalization cycle, proof of the latter’s credibility.

Evolution des points morts d'inflation 10 ans aux Etats-Unis et en Allemagne depuis 2019.

Figure 5: Evolution of 10-year break-even inflation rates in the United States and Germany since 2019.


We therefore favor short-maturity inflation-linked bonds, which we expect to offer euro-hedged returns of between 3% and 3.5% next year (real rate + realized inflation). This asset class brings an effective diversification during a period of uncertainty on inflation. Its merits, compared to the rest of the bond universe, have been demonstrated in our view since the beginning of the year (see Figure 6).

Performance du fonds G Fund - Global Inflation Short Duration (IC) du 31/12/2021 au 31/10/2022. Date de création de la part IC : 31/12/2021

Figure 6: Performance of the G Fund – Global Inflation Short Duration (IC) from 31/12/2021 to 31/10/2022. Creation date of the IC share: 31/12/2021. Sources: Groupama AM, Bloomberg.

Past performance is not a reliable indicator of future performance.


Our G FUND Global Inflation Short Duration fund appears, in our opinion, as a relevant solution in the current context by offering a global exposure to inflation-linked bonds with short maturities coupled with active management in order to outperform the benchmark.

Since the beginning of the year [2], the active management of the portfolio has outperformed its investment universe. Indeed, the fund (IC share) has posted a performance of -2.77% compared to -3.49% for its benchmark, i.e. an outperformance of 0.67%.

[2] From 31/12/2021 to 31/10/2022

Performance du fonds G Fund - Global Inflation Short Duration et de son indice de référence du 31/12/2021 au 31/10/2022. Sources : Groupama AM, Bloomberg.

Figure 6: Performance of the G Fund – Global Inflation Short Duration and its benchmark from 31/12/2021 to 31/10/2022.
Sources: Groupama AM, Bloomberg.

Past performance is not a reliable indicator of future performance.




    A rise in bond market rates may cause bond prices to fall
    There is a possibility that the capital invested may not be returned in full





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Edited by Groupama Asset Management – Headquarters: 25 rue de la ville l’Evêque, 75008 Paris – Website: http://www.groupama-am.com

Completed on 17 October 2022.