Inflation Puzzle Has $42 Billion Fund Weighing Rate Options

(Bloomberg) -- The $42 billion Swedish pension fund AP1 may veer from its usual investment strategies and buy options as diverging outlooks for inflation look set to create a new opportunity for returns, its chief executive officer said.

AP1 doesn’t typically invest in interest rate and foreign currency options “very intensively,” but circumstances are different now, Kristin Magnusson Bernard said in a phone interview.

“We think situations might arise where options strategies would be profitable due to current dispersions of investor views,” Bernard said.

Inflation has moved back onto investors’ radars, with bond yields higher across the world in recent weeks. In Sweden, price increases accelerated to the highest level in more than a year in January, figures published on Thursday by Statistics Sweden showed.

Reflecting expectations for higher inflation in Europe, German 10-year bond yields are trading around minus 0.33%, up from minus 0.45% at the start of the week, Danske Bank said in a note Friday.

Swedish Inflation Climbs to Highest Level in More Than a Year

The Riksbank is expected to ignore the spike in Sweden amid modest wage increases and changes in consumption related to the pandemic. Inflation could temporarily exceed its 2% target in coming months but probably will fall back again, the central bank has said.

Bernard said there’s a chance prices could push higher when Covid-19 restrictions are lifted. That could unleash pent-up demand among consumers who’ve been forced to save as shops and restaurants closed.

Read More: Fears of Price Surges Stoke Demand for Inflation Hedges

Still, like Sweden’s central bank, the fund expects any rise in inflation to be short-lived. There’s “no evidence that those drivers will last sufficiently long and be strong enough to keep inflation above targets for longer periods,” Bernard said.

At the same time, central bankers have made “quite a credible promise” to keep the short end of the yield curve down, Bernard said. But, the outlook for the longer end of the curve is different.

“I think there is quite some room for steepening already now on expectations of higher growth mainly and, to a lesser degree a bit higher inflation expectations,” Bernard said. The “main question” is “whether we will see more or less explicit forms of yield curve control.”

Given the considerable uncertainties, though, “obviously we might be wrong,” she said. So the fund, one of the pillars of the Swedish state pension system, is keeping a close eye on how differing market views on inflation might present new investment strategies.

Other investors “might have very different views from us,” Bernard said. “That might open up interesting opportunities that you could play, through, for example, interest rate or foreign exchange options.”

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