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Our investment professionals share and challenge each other’s views, creating a diverse marketplace of ideas for the Wellington Blog.

Two recent developments — the accelerating focus on ESG and more aggressive policy interventions — could well change the way we invest in years to come. My perspective is that of a fixed income manager, but I believe these developments will impact all asset classes.

ESG focus

A growing societal and market focus on environmental, social, and governance (ESG) issues has kickstarted a reallocation of capital, which creates new opportunities and risks for fixed income and other investors.

  • Higher inflation

In my view, the increased focus on ESG may contribute to higher inflation, at least in the short-to-medium term. Implementing environmental considerations, for instance, while desirable from a societal perspective, may involve short-term cost adjustments. This seems particularly relevant in the context of…

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SUSTAINABILITY
THEMES
Marc Piccuirro
Marc Piccuirro
CFA
Fixed Income Portfolio Manager

Many investors are increasingly seeking to protect their portfolios from the looming threat of higher inflation. Against this uncertain backdrop, I believe collateralized loan obligations (CLOs) can provide one source of refuge given their floating-rate coupons (yields), which would rise as short-term interest rates moved higher. Attractive current income relative to other credit assets and broadly positive CLO fundamentals further bolster my conviction in this often-overlooked asset class.

Where I stand on the inflation debate

Core US inflation spiked sharply in April and May 2021. For the three-month period ended in May, the Consumer Price Index (CPI) rose by 8.3% annualized, the biggest gain since the early 1980s. This has naturally exacerbated recent inflation concerns, raising questions around whether higher inflation will be transitory or more sustained. US interest rates have risen amid expectations for higher inflation, resulting in negative total returns year-to-date (through 31 May) for many fixed income sectors, especially longer-dated fixed-rate assets.

My take: While some of today’s inflationary pressures may indeed be short-lived, particularly within…

MARKETS
THEMES
Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston

The global macro discourse has shifted over the past few months to a debate around “good” versus “bad” inflation. I think there is a better way to frame it. In my view, as we look ahead, the question should be: will we see a continuation of the status quo or are we on the verge of a regime change? I think there is a high chance it will be the latter.

Over the past 20 years, there have been a number of instances when inflation has jumped higher. Often this has been due to higher energy costs, occasionally a response to strong demand and sometimes tax changes. Each time, the jump has proved short-lived, but has acted as a tax on consumers, eroding the purchasing power of households by squeezing real wages. In response, consumer spending has slowed, and the economy has cooled. In effect, these temporary bouts of inflation acted as an automatic stabiliser on the economy. Was that bad inflation? For households, yes — but not for…

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

“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

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

The Wellington Global Cycle Index1 points to an upturn in global economic activity but, in my view, even that positive prognosis is underestimating the bounce that’s ahead. Over the next six months, I predict that growth numbers almost everywhere will be exceptionally strong.

Where we differ from consensus

Almost all analysts now have the same broad roadmap for 2021 as we have — strong growth, with a gradual rise in inflation through the second half of 2021. All list the same set of risks: upside risks are attached to a full household-savings unwind and another round of fiscal support, while downside risks are attached to public health. All assume US growth leadership. What is striking is how there is actually very little discussion of inflation.

As economies reopen, it will be difficult for the market to distinguish between…

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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

ARCHIVED

Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
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

Interest rates have been rising since August 2020, with the yield on the 10-year US Treasury bond having drifted 100 basis points (bps) higher over the past six months or so. But recent rate action has really caught the market’s attention, particularly the 10-year yield’s swift 30 bps increase and the spillover into global equity markets.

Is the latest bout of “rate repricing” due to higher inflation expectations? Stronger economic growth? Treasury supply issues? “Fed fighting”? Let’s try to make sense of it all.

Yields have risen for the right reasons — Rates have been adjusting to prospects for better growth and higher inflation for months now, reflecting an improving pandemic outlook and ample policy support. Rising inflation expectations are baked into wider spreads between Treasury yields and real (inflation-adjusted) yields, using 10-year Treasury Inflation-Protected Securities (TIPs) as a proxy. Orderly rate moves have been absorbed by…

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

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

This is the third in my inflation “series” of blog posts based on ongoing client conversations. In the first one, I explained why rising inflation is not an imminent threat, but could be down the road. The next one compared today’s inflation worries with those that arose following the 2008 global financial crisis. Now I’d like to shift to a topic of even greater interest to many clients: the implications of higher inflation for investor portfolios.

Inflation can affect a portfolio in multiple ways over time. One way is through its potentially profound impact on the basic equity-bond relationship, which is typically critical to the performance and resilience of a diversified portfolio.

Dissecting the relationship

Bonds have often rallied (or at least mitigated downside) during equity market selloffs, thereby providing portfolio diversification benefits. What some investors overlook is…

MACRO
THEMES

ARCHIVED

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

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

“It’s like déjà vu all over again.” – Yogi Berra

In my last inflation blog post, dated 10 November 2020, I addressed a question that many clients have been asking lately: Are we about to enter a global “inflation era”? My short answer was (and still is) not right now, but potentially down the road. By way of follow-up, I thought I’d compare today’s inflation worries with those that arose during the quantitative-easing (QE)-fueled period after the 2008 global financial crisis (GFC).

The current inflation concerns, set amid a world of growing central bank balance sheets, ballooning fiscal deficits, and unprecedented policy innovation, echo the inflation fears raised in the post-GFC era. In the end, those latter fears proved to be unfounded, as inflation continued to decline over the ensuing decade. Why would this time be any different? To answer that, it helps to understand what the QE measures enacted in response to the GFC were actually intended to do — and why they…

MACRO
THEMES

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

The short answer is not right now, but potentially down the road. And I believe it’s less about how high inflation can go than it is about the portfolio implications of even moderately higher global inflation, which investors haven’t experienced for most of the past 30 years.

It may seem odd to talk about inflation these days. However, the substantial level of coordination between monetary and fiscal policymaking following the COVID-19 shock, with many central banks providing ample space for fiscal stimuli by buying up newly issued debt, has led to inflation coming up in many discussions with clients lately. A string of recent data releases has also helped put inflation risk back on some clients’ radars.

Nonetheless, I think it’s fair to say that many clients remain to be convinced that inflation poses a real threat to their investment portfolios, particularly because…

MACRO

ARCHIVED

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

The Federal Open Market Committee’s (FOMC)’s September statement and press conference did not deliver any big surprises. The upshot is that the US Federal Reserve (Fed) appears to be committed to maintaining its “dovish” monetary policy stance for the foreseeable future.

Look no further than the Summary of Economic Projections (SEP), released in conjunction with the FOMC meeting minutes, in which the majority of participants indicated that Fed policy rates should remain around zero through 2023. This was largely expected, given the recent shift in the Fed’s inflation framework: Whereas the Fed has historically targeted an average inflation rate of 2% over time, under the new framework, the Fed could allow inflation to…

MACRO

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston
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