Wall Street's new debasement trade idea

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Sometimes an idea is so catchy that it doesn’t matter whether it’s true. The “debasement trade” – the claim that investors are starting to price in a severe surge in inflation that will erode the value of money – is a good example. We see it everywhere in headlines at the moment. Yet it’s impossible to see much evidence in markets. To begin with, we have to agree on what is being debased. The US dollar is the favoured target. However, if you look at the dollar versus other major currencies, there is no sign of this happening. Yes, it is down since the start of the year, and still seems more likely to fall than rise against over the next few years if foreign sentiment towards US assets continues to cool. But it has been stable since June. We’re not even seeing weakness now, let alone debasement.

Maybe the debasement is in all fiat currencies, so they won’t fall against each other because they are all equally bad. Instead, they will weaken against real assets. The surge in gold and other precious metals seems to support this. Yet stocks are also doing well, even though they typically struggle in high inflation (they often rise during hyperinflation, but that is a different scenario). More likely, traders are latching onto gold because it’s been going up: record flows into gold exchange-traded funds (ETFs) support this idea. A few months ago, I noted that we were not seeing these flows – now it has changed.

Bond yields and the debasement trade

If markets were genuinely becoming much more worried about inflation, we’d expect to see it in bond yields. While many yields have risen this year – especially longer-term government bonds – this always felt more like markets were pricing long-term uncertainty about government policy and finances, not specifically forecasting inflation. It continues to look that way.

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Yields have mostly come down in the last few weeks. Even more significantly, inflation breakevens – the difference between the yields on a conventional bond and an inflation-linked one of the same maturity – are not rising (see above). Breakevens are not a good forecast of inflation, but if markets are functioning normally, they will express fear of inflation through nominal yields that rise faster than inflation-linked ones and thus through widening breakevens.

Of course, we may well see high inflation if governments run large deficits while forcing central banks to cut rates and control yields. But it’s wrong to claim the market’s watchdogs are sounding the alarm. They are clearly not – yet.

What to do if inflation surges will be on the agenda at Turmoil, Tariffs and Trump 2.0, the MoneyWeek Wealth Summit, on Friday, 7 November in London. Our morning keynote speaker, Dylan Grice, will discuss the difficulties of investing in this “high-signal” environment, while our multi-asset panel of Charlie Morris (ByteTree), Charlotte Yonge (Troy), Frank Ducomble (RIT) and Jasmine Yeo (Ruffer) will share ideas on how to hedge the risks. See moneyweekwealthsummit.co.uk for details.

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Cris Sholt Heaton is the contributing editor for MoneyWeek.

He is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is experienced in covering international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers.

He often writes about Asian equities, international income and global asset allocation.