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The 1970s were a memorable time for music, but many consumers and investors alike (at least those old enough to remember) might just as soon forget the economic “stagflation” — that toxic combination of flagging growth and soaring inflation — that plagued much of the decade. Forty-some years later, the specter of stagflation has resurfaced, as COVID-related supply-chain disruptions have persisted longer than expected and have converged with expansionary government policy (both monetary and fiscal) to push global inflation meaningfully higher in recent months.

As of this writing, the core Consumer Price Index (CPI) had reached levels well above its 20-year average range, even as GDP growth and many other leading economic indicators had weakened. Rising wages and energy prices have poured fuel on the fire, helping to create those unwelcome echoes of the 1970s — which, not surprisingly, were marked by generally poor real investment returns for…

The past several months have seen a flurry of activity in the official sector1 regarding US Treasuries, as policymakers and stakeholders attempt to explain the startling dislocations that hit the Treasury market — generally considered to be the world’s deepest, most liquid securities market — in March 2020.

Indeed, it was only through swift, aggressive intervention by the US Federal Reserve (Fed) that said market dislocations did not become even more pronounced. It marked the second time in just a few years that the central bank had to intervene in the Treasury market to restore and encourage orderly operations — the other time being the Fed’s purchase of T-bills in the fall of 2019, which was designed to stabilize the short-term interest-rate market.

Understanding what happened in March 2020

So what led to the Treasury market dislocations and illiquidity back in March 2020? At a high level, the prevailing narrative is that…

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Amar Reganti
Amar Reganti
Investment Director
Boston

As foreshadowed by US Federal Reserve (Fed) Chair Jerome Powell in his recent congressional testimony, as well as by other Fed officials, the Federal Open Market Committee (FOMC) yesterday accelerated the timeline for tapering its large-scale asset purchase program. The Fed’s monthly purchases of US Treasuries and agency mortgage-backed securities (MBS) will decline at a faster pace over the next few months, before coming to an end in March 2022. The culprit: rising inflation.

US inflation has been running persistently higher than both the Fed’s forecasts and its target range and has shown signs of broadening out across more goods and services. In response, the FOMC increased its inflation forecasts while also decreasing its growth outlook, as labor shortages and supply-chain bottlenecks have created greater inflationary pressures than the FOMC previously anticipated. The mounting inflationary risks also led the median FOMC participant to now expect the FOMC to hike interest rates three times in 2022 and three times in 2023. The US Treasury yield curve flattened following the release of the FOMC’s revised summary of economic projections, as the front end of the curve moved higher.

When will the Fed start reducing its balance sheet?

While not an imminent risk, market participants will eventually turn their attention to the timing of the Fed’s upcoming…

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

As discussed in my recently published 2022 Fixed Income Outlook, co-authored by my colleague Jitu Naidu, we believe inflation and interest-rate risks look poised to supplant the global COVID-19 pandemic as the new “bogeymen” facing investors in 2022. The dual specter of persistently higher inflation and steadily rising rates has many allocators particularly worried about potential implications for their fixed income exposures. Accordingly, many are now seeking defensive portfolio strategies — so-called “hedges” — for the new year.

Possible inflation scenarios

Market pricing for longer-term US inflation was recently in the mid-2% range, based on the latest “breakeven” inflation rates. There are still ongoing debates as to likely inflation outcomes going forward, but most of the informed forecasts appear to…

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Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

The short answer, as discussed below, is probably not, but it’s a fast-moving narrative that warrants some level of concern (though not panic). Here’s what we know and don’t know at this point and my thoughts on some of the potential implications.

What we know

Omicron is a new variant of COVID-19 that was first identified in South Africa, where it’s now the dominant strain of the virus. As of this writing, it has already spread to (and within) a number of other countries and regions, including Botswana, Hong Kong, Europe, and Israel. According to initial reports, most of the cases seen so far are concentrated among younger patients, who tend to be either unvaccinated or not fully vaccinated. (For context, South Africa’s vaccination rate is approximately 25%.)

Our health care analysts tell me that the mRNA vaccine is best positioned to be modified to provide protection from new COVID variants. An Omicron-specific version of the mRNA vaccine could be available in as little as…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

Every quarter, the Wisdom of Wellington team surveys around 100 of our Wellington colleagues across different investment disciplines and locations to get their views on what we see as the key macro questions of the day. The results can pinpoint where the firm’s views differ from the consensus and can also reveal important shifts in our collective thinking.

The latest survey shows that, while the risk of a US recession is still considered low by historical standards, the probability of stagflation has increased. In our previous survey, 50% of participants noted the risk of a significant upside surprise in US inflation, but that figure has now risen to 63% (Figure 1).

FIGURE 1

The probablity % of a significant US inflation surprise has increased
At the same time, our respondents thought the economic cycle was…

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Benjamin Cooper
Ben Cooper
CFA
Multi-Asset Strategist
London
Juhi Dhawan headshot
Juhi Dhawan
PhD
Macro Strategist
Boston

The US Federal Reserve’s (Fed’s) message on inflation has changed. Fed Chair Jerome Powell recently characterized supply shocks, bottlenecks, and disruptions as “frustrating” and as “holding up inflation longer than we had thought.” The Fed’s mea culpa is small consolation for investors whose portfolios have not been positioned optimally for a longer-than-expected period of higher inflation.

The question now is: Has inflation already peaked? The short answer is no, in my opinion.

The systemic nature of supply shocks

Inflation is being pushed higher by three catalysts — labor, raw materials, and transportation — that are interrelated in ways that…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

Today’s record gas prices in Europe and Asia come with wide-ranging ramifications that investors need to be aware of.

Natural gas has been cheap for so long that investors and policymakers may have underestimated its pivotal role in modern-day economies. Now a combination of factors is driving steep increases in European and Asian power prices with the real possibility of shortages. Looking beyond the immediate repercussions we see significant investment implications.

In the short run, high power prices could mean:

  • Switching from gas to oil — Typically, only developing countries use oil for power generation as oil is easier to access and transport, but if shortages were to occur, Europe and East Asia could…
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Eugene Khmelnik
Eugene Khmelnik
Global Industry Analyst
London

With a sustained rise in interest rates in the coming months a distinct possibility as of this writing, we thought now would be an opportune time to take a close look at some potential impacts of higher rates on clients’ fixed income portfolios. To do so, we compared the hypothetical five-year performance of the Bloomberg US Aggregate Bond Index under three different illustrative scenarios that could play out going forward: 1) rates remain unchanged; 2) rates rise abruptly; and 3) rates rise gradually (i.e., over three years).

Key takeaways for fixed income investors

A few of our main takeaways from this analysis were as follows:

  • While abrupt rises in rates might lead to short-term drawdowns in fixed income portfolios, they can at times be desirable for longer-term investors, given opportunities to…
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Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

I spent 10 days in Brazil in August 2021, visiting technology, retail, real estate, and health care companies in search of stocks to add to my potential “buy” list. I met with 22 corporate CEOs, 21 of whom told me I was the first foreign investor they’d seen in person since pre-COVID. Many of them chatted with me for over an hour — a vivid illustration of how there is just no substitute for being on the ground in emerging markets (EMs), especially at a time like this.

I departed with some valuable insights into a number of companies that led me to better appreciate the robustness of their business models. Indeed, there are plenty of stock- and industry-specific investment opportunities in Brazil, which I’ll explore in a future blog post. But at the broad country level, I left with a decidedly more negative take. The analogy that came to mind was that of Brazil being in a “straitjacket,” with all the unpleasant…

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Jamie Rice
Jamie Rice
CFA
Equity Portfolio Manager
Boston
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It’s a common question that’s been hovering over the global investment landscape in recent days. In a word, I feel confident the answer is “no.” And a related question: Can China overcome its longer-term debt and capacity problems? I think the answer there is probably “yes,” if given enough time. Let’s have a closer look at this still-evolving situation.

My overarching conclusion: This is not China’s Lehman

The recent high-profile debt woes of China’s second-largest property developer have riled global markets and sparked widespread fears of a brewing systemic crisis that could spread from China to the US and the rest of the world. I suspect those concerns are overblown and largely unfounded. In fact, I believe the risk of a systemic Chinese crisis with contagion potential is…

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Santiago Millan headshot
Santiago Millán
CFA
Macro Strategist
Hong Kong

From rising inflation to the COVID Delta variant and more, there is no shortage of risks and challenges facing investors in today’s global market landscape. But from our perspective, many fixed income market participants have been more or less “looking past” such macro concerns in favor of a more upbeat narrative around continued economic recovery and growth. This narrative has gained ample support from the global trend of ongoing monetary and fiscal policy stimulus, particularly in the US, since the onset of COVID. What happens in Washington doesn’t stay in Washington.

With that in mind, let’s examine the key US government policy catalysts that have been moving fixed income markets in recent months and may continue to do so in the…

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Amar Reganti
Amar Reganti
Investment Director
Boston
Jitu Naidu
Investment Communications Manager
Boston

At long last, a more concrete timeline has been unveiled for the much-anticipated removal of US monetary policy accommodation. The Federal Open Market Committee’s (FOMC’s) September 2021 statement and Chair Jerome Powell’s press conference indicated that the FOMC could begin tapering its large-scale asset purchases in November 2021 amid ongoing economic improvement, and that the process could be concluded as early as mid-2022.

The FOMC increased its inflation forecasts and decreased its growth outlook, as labor supply shortages and supply-chain bottlenecks have created greater inflationary pressures than the FOMC previously anticipated. The rising inflationary risks also led the median FOMC participant to now expect the FOMC to hike interest rates three times by the end of 2023 (closer to market pricing) and an additional three times by…

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

In a June 2021 white paper, A source-based approach to managing inflation risk, co-authored by our colleague Adam Berger, we laid out what we believe are the five most likely sources of higher inflation over the coming decade. One of them was climate risk or, more specifically, the potential for input price shocks caused by the ongoing trend of global climate change. Since this inflation source may not be on many investors’ radar, we’d like to revisit why we think climate change is inflationary and suggest strategies to help reduce the threat to client portfolios.

The relationship between climate change and inflation

  • Overview: A price shock to a systemically important input price will tend to spur higher inflation as businesses pass it on to consumers, leading to “cost-push” inflation. While this has historically been due to geopolitical forces driving oil prices, we believe the impact of climate change on a range of commodities will be…
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Samouilhan_Nick
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore
Joy Perry
Joy Perry
Investment Director
Boston, MA

After a lengthy absence, inflation has finally returned to the US, but for how long depends on who you ask. Many observers, including the US Federal Reserve (Fed), continue to expect today’s inflationary pressures to be more or less “transitory” in nature. Market pricing suggests that many investors share that belief.

However, here are five reasons why I believe US inflation could prove to be far more enduring than widely expected by the Fed and market participants.

  1. A still-early economic cycle: The US economic cycle is still in its very early stages, as shown by the recent high level of…
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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

In my opinion, the answer to the question above is “less than most people expect.” I think life will return to “normal” in ways that may be hard to imagine amid worries about the Delta variant. Early in the pandemic, my colleague Eunhak Bae wrote the following about living through 9/11 in New York City: “In the immediate aftermath, it seemed like no one would ever fly on a plane again. That obviously turned out not to be true. Today, it may feel like the world has changed for good. But I believe humans are blessed with selective memories and a desire to revert to what they know, so people will once more buy things, go see things, and congregate to share experiences.” When I first read those words, I thought the reversion to normal would happen much more quickly than it did, but I still think that’s our destination, perhaps within the next six – 12 months.

Why inflation will be an exception

The big change I foresee is in inflation, which has been unusually low for an extended time (1.4% over the decade ended December 2021 and 1.6% for the trailing 15 years). We have seen in past crises that economic stimulus tends to be harder to…

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Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

In light of some notable events over the past several weeks — China’s domestic regulatory actions, the Biden administration’s recent six-month milestone, and the US foreign policy debacle in Afghanistan — I thought now would be an opportune time to provide my latest take on the state of US-China relations.

Putting regulation in context

As many of my colleagues have observed, the recent regulatory moves by Beijing are mainly China-focused and not driven by global geopolitics or US policy shifts. That being said, there are some key takeaways here from my broader geopolitical perspective. For example, I think policymakers in both China and the US have begun to view their domestic policy decisions through the lens of the rising “great-power” competition between…

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Thomas Mucha
Thomas Mucha
Geopolitical Strategist
Boston

There is a sense that the world is slowly “getting back to normal,” after more than a year of COVID-induced economic lockdowns and other restrictions. Unfortunately, many countries — and even some parts of the US — are still grappling with more contagious and virulent strains of the virus (e.g., the so-called “Delta variant”) and troublingly low COVID vaccination rates. We are not out of the woods yet. But broadly speaking, the global economy has been recovering with the aid of accommodative fiscal and monetary policy, supporting the strong performance of risk assets and the ongoing rotation from growth- to value-oriented exposures.

The threat of rising inflation is a bogeyman now. Amid supply/demand imbalances in labor and other factors, we believe inflationary pressures are likely to persist in the period ahead. Against this backdrop, our investment outlook remains largely pro-risk, but is tempered to some degree by what we see as…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
Daniel Cook
Daniel Cook
CFA
Investment Strategy Analyst

I believe that regional differences in COVID vaccination rates, government policy goals, and the ensuing trade-offs have led to a global economy that can now broadly (and imperfectly) be divided into three distinct ”blocks,” each moving at very different speeds and via very different catalysts: 1) the ”boosters”; 2) the COVID “racers”; and 3) the ”reformers” (Figure 1).

In my view, investors should track the dynamics of each block separately in order to successfully navigate the current phase of the global economic recovery. All three will also affect the markets to varying degrees and with varying effects.

Figure 1

The three blocks of the global economy

Block 1: The ”boosters”

The countries in this group have made substantial progress on vaccine provision, which has increasingly allowed them to…

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Samouilhan_Nick
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore

As credit spreads have compressed to post-global financial crisis tights, and with bond yields hovering near all-time lows, I believe the total and excess return prospects for investment-grade fixed income look rather grim. Tight valuations, coupled with some looming risks on the horizon (the COVID Delta variant, inflationary pressures, fading fiscal stimulus, and China’s slowdown), may present an opportunity to “take some chips off the table,” so to speak. I recommend reducing both credit and interest-rate risk in many investor portfolios.

The technical backdrop remains strong

Investment-grade credit has been well-supported by strong demand from non-US investors and the domestic pension community. For overseas investors, US credit is still their best option on the yield “menu” (made even more attractive on a currency-hedged basis), given lower prevailing yields across most other developed markets. Many defined benefit pension plans have been…

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Connor Fitzgerald
Connor Fitzgerald
Fixed Income Portfolio Manager
Boston
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