dealtn wrote:TheMotorcycleBoy wrote:colin wrote:Over the next two years gilt market has priced inflation of just over 2% pa so not much change there, of course if TheMotorcycleBoy has read the sensible investing books recommended to him a while back then he will know how much weight to place on that expectation, but certainly it's a better way of getting some idea of what 'every one else' thinks than inviting a cacophony of conflicting opinions on the internet.
To be frank, I'm interested in all these matters, and have read some and am interested in reading more.
Let me ask you something if you don't mind. Firstly if you open this link https://seekingalpha.com/article/427635 ... -weirdness and search out "Exhibit 4: the U.K", then can you answer me: Which maturity gilts do we use as the proxy for CPI inflation? The 30yr bond, 48yr one, etc.?
Then if you look at this page: https://www.ons.gov.uk/economy/inflatio ... ctober2019 observe that through from period aug-oct, measured CPI inflation seemingly just slightly (1.5-1.7%) above that forecast by 30 yr gilt yields (for example about 1.4% ), but the similarity is still impressive.
FWIW I find the concept (and reality) of this equivalence quite interesting. What is it actually telling us? My first thoughts are that there must a very large mixed class of investors that are prepared to accept an asset class whose yields mean that the £££ they put down at time X will be exchangeable for the exactly same value of money to some point in the future. Hopefully. Pension funds I guess.
I also wonder, what forces such (long dated) gilt yields up or down. I imagine a super-rich yacht owner tycoon who thinks "Shall I buy a new yacht this month?". "Hmm I suspect inflation, hence prices, are rising soon, I better spend my £££ now before it loses value". Hence he cashes in all his 30 yr gilts making their price fall, and hence their yield rise. I did the same thought experiment in reverse, and that made sense too.
Matt
The inflation rate isn't derived from the gilt curve in that way.
Each point on that curve is (very simplistically) an average of the daily gilt yield from today, repeated daily, until that maturity date. But that is an interest rate, not an inflation rate. Similarly we have an index linked gilt curve, and every point on that curve is the "average of the daily rate on the linker curve". But this isn't an inflation curve either. However by combining the two curves you can derive the inflation rate, combining the (forward) "yield curve" with the (forward) "real yield curve" you can plot a market implied path of inflation.
Now it is even more complicated than that. Firstly because the Index Linked Gilts are RPI instruments, and you are looking for CPI. This too though can be calculated, since a CPI-RPI inflation derivative curve also exists, to allow CPI paths to be constructed also.
Most importantly though this "theory" all assumes the supply-demand equilibrium that derives the prices, and hence yields (and thence inflation) are all "perfect". But they (very much) aren't. Firstly there is a lack of liquidity. Then you have to consider the distortions in (both) Gilt markets, where for some time, and likely to continue for some time, a large "extra" demand exists from pension funds "obliged" to liability match, which distorts the true price. Then you have similar distortions due to historic, and now current QE. Then you also need to factor in what is the "Government Credit curve". That is to say part of the required yield for Gilts, especially in the long end, reflects the (tiny but growing) possibility that the Government might not be able to pay back the borrowing (or will engage in deliberate inflation to erode the real size of the debt).
So. It's very complicated.
Well, it's far too complicated for me, but I'm interested in what you said about the Government engaging in deliberate inflation. How can they do that?
Steve