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Whiffs of the long-awaited “taper talk” around US monetary policy are finally in the air. The Federal Open Market Committee’s (FOMC’s) June 2021 statement and press conference indicated that the FOMC has discussed when it ought to start tapering its large-scale asset purchases amid the ongoing economic rebound and mounting inflationary pressures.

The FOMC upgraded its US growth and inflation forecasts, yet kept its unemployment rate forecast unchanged, as labor supply shortages in an environment of strong consumption are leading to higher inflation than the FOMC previously anticipated. The increasing inflationary risks also resulted in the median FOMC participant now expecting to hike interest rates twice during…

MACRO
Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

As I consider various potential sources of market volatility over the coming months, the one I believe poses the biggest threat to today’s constructive backdrop for risk assets is so-called “bad inflation.” The costs of intermediate goods and inputs to production are climbing at their fastest pace in decades, which presents a likely headwind to corporate profit margins. Additionally, commodity prices are all rising in unison, be it coffee, corn, lumber, sugar, wheat, or gasoline, further straining corporate and consumer budgets.

Where the Fed may be wrong

The US Federal Reserve (Fed) has repeatedly stated its intention to “look through” the inflationary surge we’re seeing today, which it views as transitory. The Fed seems to assume that supply will quickly come back online as the economy reopens and recovers, allowing pricing pressures to abate. I hold a different view. I suspect that productive capacity for commodities in particular will not bounce back as swiftly as the Fed is forecasting. To be clear, I believe much of today’s bad inflation is being driven, either directly or indirectly, by these rising commodity prices and will therefore prove “stickier” and more stubborn than the Fed expects.

A paradigm shift in the making

As I see it, the public companies that have been rewarded the most over the past decade have behaved more or less like rent-seeking monopolies. Many investors covet steady, predictable cash flows to which they can apply a low discount rate. Conversely, some of the best…

MACRO
Connor Fitzgerald
Connor Fitzgerald
Fixed Income Portfolio Manager
Boston

The job gains cited in the May 2021 non-farm payrolls release fell well short of what the market had hoped. A fluke? Maybe, but this disappointing jobs report suggests to me that US inflation dynamics are beginning to shift from “demand-pull” to “cost-push” inflation.

The perils of cost-push inflation

Demand-pull inflation is the upward pressure on prices that occurs when aggregate demand outpaces aggregate supply. Cost-push inflation, by contrast, is caused by increased costs for raw materials, wages, and other inputs to production. The latter type of inflation tends to be much more harmful to an economy, as it forces companies to choose from among three distinct (and all undesirable) options:

  1. Seek to cut their capital costs elsewhere to preserve profit margins
  2. Invest in productivity-boosting solutions to reduce their labor costs
  3. Pass their increased costs on to consumers in the form of higher prices

The most probable scenario, in my judgment, is…

MACRO
Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

I think one of the biggest catalysts behind the general rise of the US dollar (USD) over the last 10 years or so has been the marked improvement we have seen in the US energy trade balance.

The so-called “shale revolution” has benefited the US economy in myriad ways, from enhanced productivity to higher levels of employment and increased tax revenues. However, the degree to which it has helped to moderate the underlying deterioration in the US current-account deficit has gone largely underappreciated. That, in turn, has been a tailwind for the USD for most of the past decade. I’m just not sure how much longer…

MACRO
MARKETS
Brian Garvey
Brian Garvey
Multi-Asset Portfolio Manager

For fixed income investors, varying the amount of credit risk in your portfolio can exert a major influence on the portfolio’s realized alpha. Indeed, historical data shows that this single factor can have a larger impact than decisions around what bond sectors or individual issuers to invest in. Accordingly, it’s worth spending some time thinking about precisely how much credit risk to take and when. My latest research in this area focuses on the role that valuation can play in adjusting credit risk over an economic cycle.

Methodology at a glance

I looked at the strategic timing of buying and selling credit exposure (in the form of corporate bonds, using cash or US Treasuries as a funding source) with low turnover, and using market valuation as the sole buy/sell signal. There are, of course, other predictive drivers of credit returns, such as…

MACRO
MARKETS
Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

“We suggest that a budget constraint be replaced by an inflation constraint.”
— Three MMT economists in a 2019 letter to the Financial Times

MMT in a nutshell

Modern Monetary Theory (MMT) is often dismissed as a fringe concept regarding unlimited government spending, but it’s a bit more nuanced than that. Basically, MMT holds that a nation’s budget doesn’t (or shouldn’t) really constrain spending because the government can always print more money if needed. Thus, it’s the “real” economy — the production, purchase, and flow of goods and services — that truly matters.

Taking it a step further, the government can theoretically spend as much as it wants to until said spending begins to create excess demand, thereby generating inflation, at which point the government should…

MACRO
MARKETS
Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston

Based on the most recent available data, March 2021 was the first month ever in which Chinese imports exceeded US imports (Figure 1). China was already the world’s largest trader overall (imports plus exports), but this latest development now also makes it the largest source of both global demand (imports) and global supply (exports). This is a notable milestone and perhaps another step toward China eventually surpassing the US as the world’s biggest economy (which, as I observed in my February 2021 blog post, could occur as early as 2028).

The strong import number, together with a weaker-than-expected export number and the potential for further export weakness as the world normalizes, could put some near-term pressure on…

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.

In January’s survey, we asked which risks the market was most complacent about. This quarter, we followed up by asking respondents to rank which upside risks the market should be focusing on (Figure 1). The number two upside risk was the potential release of pent-up savings amassed during the pandemic, which has already been the subject of widespread comment. But the top-ranked upside risk — of a structural boom in capital expenditure (capex) — has attracted far less comment. Many of our macro thinkers believe that the market is underestimating the potential for a lasting increase in capex fueled by investment in green initiatives and infrastructure…

MACRO
THEMES
Benjamin Cooper
Ben Cooper
CFA
Multi-Asset Strategist
London

The US Federal Reserve’s (Fed’s) message on inflation is clear: Higher domestic inflation is likely in the period ahead, but it should be “temporary” in nature. This begs several questions, among them: What exactly does “temporary” mean? Which price increases, if any, could be longer lasting? And if higher inflation proves to be “stickier” than anticipated, how should investors position their portfolios?

The Fed’s latest forecast is for the Consumer Price Index (CPI) to rise to 2.6% this year (which it already hit in March), before settling back down to just over 2% in 2022 and 2023. Likewise, market expectations (as observed in recent “breakeven” inflation rates) are for US inflation to pick up in the near term and then come down longer term. Yet I am hearing from some of my analyst colleagues that many areas of the economy are facing stubborn supply shortages and upward price pressures, including freight, semiconductors, housing, raw materials, and labor.

Thus, in my view, the risk is that higher inflation may have a longer-than-expected “tail” before…

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

As discussed in my latest white paper, An allocator’s agenda for a reflating world, I’m concerned that many asset allocators seem to remain stubbornly positioned for a world of falling bond yields, declining inflation, and low economic growth. In my view, this is largely due to what I call a persistent “status-quo bias,” rather than much in the way of active positioning for the realities of today’s evolving global landscape.

As a result, I believe many clients have portfolio positioning that is ill-equipped to successfully navigate the potentially reflationary period ahead. The remedy? While I certainly don’t recommend a wholesale shift to all “reflationary” assets, I think one important item on every allocator’s “to-do” list should be…

MACRO
MARKETS
Nick Samouilhan
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore
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The US military defines a “complex catastrophe” as a “natural or man-made incident […] which results in cascading failures of multiple, interdependent, critical, life-sustaining infrastructure sectors and causes extraordinary levels of mass casualties, damage, or disruption severely affecting the population, environment, economy, public health, national morale, response efforts, and/or government functions.”1

Working with Wellington’s Climate Research Team, our Global Macro Team is studying the macro, market, and geopolitical implications of climate change. We see climate change as a complex catastrophe in the making, with the potential to exacerbate geopolitical instability and multiply threats to economic and national security. Governments, including the US, China, and European Union, are beginning to treat climate change as a structural peril. Under the Biden administration, climate change has…

MACRO
SUSTAINABILITY

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Thomas Mucha
Thomas Mucha
Geopolitical Strategist
Boston

Investors can breathe a collective sigh of relief — for now anyway. The Federal Open Market Committee’s (FOMC’s) March statement and press conference suggested that the FOMC is likely to look through any inflation pickups this year and wait until the labor market has recovered to assess whether inflation can sustainably stay around 2%.

The FOMC projects significant improvement in the unemployment rate and a modest overshoot of its 2% average inflation target in 2021. But even against expectations for higher growth and inflation this year, the median FOMC member’s forecast still anticipated the…

MACRO

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

The transition to the “sunsetting” of long-standing LIBOR benchmarks — initially slated for 31 December 2021 — has been fraught with delays and uncertainty, thanks in no small part to the ongoing COVID-19 crisis. There has been progress, however. A number of recent developments reinforce the commitment by regulators and central banks to wean market participants off their reliance on IBORs (interbank offered rates) and to embrace alternative reference rates.

The UK FCA announcement

  • On March 5, the UK’s Financial Conduct Authority (FCA) officially announced the eagerly anticipated cessation and non-representation dates on 35 LIBOR benchmarks across various tenors and…
MACRO

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Matthew House
Matthew House
Fixed Income Portfolio Analyst
Boston

Every quarter, we survey around 100 of our Wellington colleagues in different investment disciplines and locations to get their views on what we see as the key macro questions of the day.

We believe that the framing of the questions is crucial. For example, many surveys ask respondents to list what they see as the current key risks. In our survey, we ask for the top three risks our participants believe the market is most complacent about. That requires them first to think about the risks — which are often fairly evident — and then to grade them on how far they are priced into markets. For us as investors, that is clearly the more important information, as it can help us to identify areas where the markets are mispricing risk and thus creating…

MACRO

ARCHIVED

Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London
Benjamin Cooper
Ben Cooper
CFA
Multi-Asset Strategist
London

In my conversations with clients at the end of 2020, many of the same questions kept coming up. Here are five that topped the list, along with my thoughts in response.

#1: Given last year’s robust market gains and the current state of the economy, how optimistic are you about 2021?

There are always risks for investors to navigate. Notably, this latest surge in COVID-19 cases, hospitalizations, and deaths marks a tragic phase in the ongoing global health crisis. However, as we learned in 2020, markets are forward looking. I believe the recently approved COVID vaccines, gradually reopening economies, and easy fiscal and monetary policy should provide a supportive backdrop for potentially solid gains from risk assets in 2021. So optimism seems in order, but given that is the consensus view, I am only moderately bullish on global equities as of this writing.

FIGURE 1

There is pent-up demand to “get back to normal”

#2: What’s your take on what a Biden presidency might look like?

Many investors are concerned about a progressive Biden agenda. However, the president-elect’s razor-thin majorities in the House and Senate and a low likelihood of removing the Senate filibuster have dimmed chances for proposals like the “Green New Deal” and “Medicare for All.” That said…

MACRO
MARKETS

ARCHIVED

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

In my conversations with clients at the end of 2020, many of the same questions kept coming up. Here are five that topped the list, along with my thoughts in response.

#1: Given last year’s robust market gains and the current state of the economy, how optimistic are you about 2021?

There are always risks for investors to navigate. Notably, this latest surge in COVID-19 cases, hospitalizations, and deaths marks a tragic phase in the ongoing global health crisis. However, as we learned in 2020, markets are forward looking. I believe the recently approved COVID vaccines, gradually reopening economies, and easy fiscal and monetary policy should provide a supportive backdrop for potentially solid gains from risk assets in 2021. So optimism seems in order, but given that is the consensus view, I am only moderately bullish on global equities as of this writing.

Figure 1

US Dallas Fed Mobility Engagement Index ("Social Distancing" Index)

#2: What’s your take on what a Biden presidency might look like?

Many investors are concerned about a progressive Biden agenda. However, the president-elect’s razor-thin majorities in the House and Senate and a low likelihood of removing the Senate filibuster have dimmed chances for proposals like the “Green New Deal” and “Medicare for All.” That said…

MACRO
MARKETS

ARCHIVED

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

In my conversations with clients at the end of 2020, many of the same questions kept coming up. Here are five that topped the list, along with my thoughts in response.

#1: Given last year’s robust market gains and the current state of the economy, how optimistic are you about 2021?

There are always risks for investors to navigate. Notably, this latest surge in COVID-19 cases, hospitalizations, and deaths marks a tragic phase in the ongoing global health crisis. However, as we learned in 2020, markets are forward looking. I believe the recently approved COVID vaccines, gradually reopening economies, and easy fiscal and monetary policy should provide a supportive backdrop for potentially solid gains from risk assets in 2021. So optimism seems in order, but given that is the consensus view, I am only moderately bullish on global equities as of this writing.

Figure 1

There is pent-up demand to “get back to normal”

#2: What’s your take on what a Biden presidency might look like?

Many investors are concerned about a progressive Biden agenda. However, the president-elect’s razor-thin majorities in the House and Senate and a low likelihood of removing the Senate filibuster have dimmed chances for proposals like the “Green New Deal” and “Medicare for All.” That said…

MACRO
MARKETS

ARCHIVED

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

The Federal Open Market Committee’s (FOMC’s) December statement and press conference provided additional assurance that asset buying would continue for the foreseeable future, noting that purchases of US Treasuries and agency mortgage-backed securities (MBS) would proceed at their current pace at least until “substantial further progress has been made” on the labor market and inflation outlooks.

The US Federal Reserve (Fed) appears committed to its dovish monetary policy stance and will likely continue to provide extraordinary accommodation as long as necessary. This is largely because, despite ongoing improvement, the US economic outlook remains highly uncertain. A downside surprise regarding… 

MACRO

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

Remarkable, painful, unsettling, hopeful… 2020 brought a roller-coaster ride of emotions, not to mention its share of economic and market volatility. So, with the US elections pretty much behind us, further US fiscal stimulus on hold (for now), and COVID cases spiking in the US and Europe (but with progress toward a vaccine), what’s our investment thesis for 2021?

Over our 12-month horizon, the promise of more good news on the vaccine front, along with gradually reopening economies and strong government policy support, make us more confident that we’ll begin to see the global economy recover from still-depressed levels. We believe the improving economic backdrop and the prospect of a safe, effective vaccine should be catalysts for a turning point in the market narrative — a broad, durable rotation from growth assets into their value counterparts. This could well be an enduring theme going forward.

Global equities: Leaning toward value

We expect a range of value-type equity exposures to outperform in 2021, including overseas developed markets (Europe and Japan versus the US), emerging markets, smaller-cap stocks, and cyclical sectors (such as financials) versus growth sectors. In addition to financials, sectors we find attractive include…

MACRO
MARKETS

ARCHIVED

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

Japan has experienced deflation for much of the past 30 years (Figure 1). That’s the general consensus, so why my titular question? Because what Japan has not had over the past three decades is the sort of broad wage-service deflation that is most feared by economists. Instead, I would characterise Japan’s deflation as having been mostly idiosyncratic in nature.

Figure 1

Is Japan's deflation cycle at the end?

Deflation was mostly idiosyncratic

Japan’s protracted battle with deflation was largely attributable to specific dynamics, including the country’s botched policy response to its 1980s asset-price bubble, whose collapse in 1991 ushered in Japan’s so-called “lost decade” — a period of economic stagnation that lasted until 2001. In addition, I believe the massive…

MACRO
THEMES

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Paul Cavey
Paul Cavey
Macro Strategist
Hong Kong
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