Most of the past decade-plus has been characterized by declining interest rates and tightening credit spreads. Against this backdrop, many traditional fixed income benchmarks have performed well, particularly those with longer durations and meaningful credit components.
However, we believe 2021 could mark a transition to a new fixed income reality wrought by ongoing structural changes, potentially leading to more frequent dislocations across market sectors. Here we describe the secular forces that we believe are driving these changes, to be followed by a proposed solution for fixed income investors in our next blog post.
Structural shifts in consumer behavior
The COVID-19 crisis has driven increased adoption of technology and structural shifts in consumer behavior, some of which are unlikely to reverse even after the pandemic recedes, including:
- Growth of online shopping: E-commerce’s share of retail sales has grown rapidly, fueled by economic lockdowns, changing consumer preferences, and big cost/time savings.
- Greater use of telemedicine: The widespread use of telemedicine during the pandemic has reduced health care costs and improved the efficient delivery of care and services.
- Reinventing office space: The rise of remote working and a corresponding decline in the need for physical office space could end up being one of the pandemic’s lasting legacies.
While these trends may slow or partially backtrack, many businesses will have been permanently altered in a post-pandemic world. As a result, we believe stubbornly low US productivity may be poised to climb in the period ahead.
New era of fiscal/monetary coordination
The playbook for combating economic downturns has been largely rewritten, ushering in a new era of fiscal/monetary policy coordination over the past year. Governments globally have continued to provide generous fiscal stimulus in response to the COVID crisis, while central bankers have signaled their intention to keep interest rates low even as recovery takes hold. All of this policy support has implications for the future path of inflation.
Following a volatile year in 2020, we anticipate a regime shift in inflation and a likelihood that it will vary by country. Inflation has been consistently below central banks’ targets (Figure 1), but we see multiple ingredients falling into place for potentially higher inflation going forward: public acceptance of greater fiscal/monetary coordination, mounting cost pressures across the economy, the possibility of recovery-led “demand pull-forward,” and a feedback cycle of realized inflation and inflation expectations.
FIGURE 1
No-rules world of deglobalization
The decades-long trend toward globalization may have finally come to an end. Indeed, we believe the world is gradually moving toward a “no-rules” landscape of deglobalization — a kind of “zero-sum” game where many countries will be more or less left to fend for themselves, likely implying more differentiation across global interest rates and a greater abundance of relative-value investment opportunities.
Deglobalization (like globalization before it) will be a slow-paced trend, but its various impacts can accrue swiftly and have recently been accelerated by the disparity of individual country responses to the pandemic. Potential implications include: increased market volatility, widening credit spreads, dispersion in sovereign yields, and a higher probability of exogenous events that affect global economies. Our colleagues, Fixed Income Portfolio Manager John Soukas and Investment Director Chris Doherty, have more fully explored this topic here.
To be continued
In our next blog post, we will outline four steps investors can take to build a new fixed income allocation that we believe will be better suited to generating total return in today’s environment.
