MAIN MENU

#WellSaid

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

Fixed income investors just experienced a “once-in-a-career” market correction: a 10% decline in the Bloomberg Barclays US Aggregate Bond Index (the “Agg”) through the first four months of 2022. For most allocators, this sharp downturn came in tandem with a painful equity market sell-off that has produced a -15% return for the S&P 500 Index year-to-date. It’s been rough sledding for traditional assets so far this year.

The forces behind the fixed income correction are by now familiar to market participants: rising interest rates, triggered largely by higher and stickier inflation than expected, and a scramble by the US Federal Reserve (Fed) to play “catch up” — in other words, to rein in inflation before a vicious cycle of surging wages and even higher prices takes hold. What now? I’m still hesitant to call a “top” for how high 10-year US rates might climb (beyond 3%) because the trajectory of future inflation remains highly uncertain, but I see tentative signs that we may be nearing a plateau. Below are four considerations that have me leaning…

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

After years of near deflation across much of Europe, the region is now witnessing persistent price increases. Second-order effects of recent geopolitical developments, particularly the ongoing war in Ukraine, are intensifying the current inflationary environment. This apparent shift to a higher inflation regime, with the resulting expectation of tighter monetary policy and rising interest rates, presents a material challenge for European fixed income investors, raising questions such as:

  1. Should I consider adjusting my portfolio allocations based on higher inflation risk?
  2. What are the most attractive fixed income sectors in an inflationary environment?
  3. Where are there still pockets of value and opportunity in global financial markets?

How best to answer these questions depends on the specific circumstances of each investor, but over the coming months, we aim to share some pointers to help European investors think through the implications of higher inflation for their fixed income portfolios. As a first step, let’s take a closer look at…

MACRO
MARKETS
Will Prentis
Will Prentis
Investment Analyst
London
Tobias Ripka
Tobias Ripka
CFA
Investment Director
Frankfurt

An inverted US Treasury yield curve is often viewed as a reliable recession indicator, so the significant flattening of the curve over the past few months — and in an environment of persistent inflationary pressures, to boot — has some economic prognosticators calling for an impending US recession. I say not so fast.

While I acknowledge that the economic outlook will likely deteriorate at the margin as monetary policy tightens, particularly if energy prices remain elevated, I do not believe the recent flattening of the yield curve portends a US recession in the near term. US consumer balance sheets look very healthy, household savings rates are robust, and rising worker wages may help cushion against the impact of higher goods and energy prices. Furthermore, the US should remain relatively shielded from today’s uncertain geopolitical landscape, given its lower oil imports from Russia and its greater…

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

Now that the Federal Reserve has moved into tightening mode, it’s worth asking when the US deficits and overall debt could become a source of worry. As long as interest rates stay reasonably low without driving persistently high inflation, I believe deficits and the debt won’t matter too much to the economy or markets. The debt won’t be painful to finance and can continue to grow — within reason. In fact, if economic growth is higher than the interest rate on government borrowing, it’s possible for debt to GDP to shrink even amid sizeable deficits.

The risk of regime change

If rates move up dramatically, however, the cost of financing the debt will go up and pressure the deficit, as higher debt servicing costs will either crowd out other government spending (unlikely) or increase the deficit further (compounding the problem).

For this reason, I think the Fed will be cautious in its tightening approach, with an eye on the “terminal value” of rate hikes. It can steer short rates directly, but shorter-term Treasury bills constitute a little less than 20% of the debt. To influence longer-term rates, it can…

MACRO
MARKETS
Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

As widely expected, the Federal Open Market Committee (FOMC) yesterday raised its target federal funds rate (for the first time since 2018!) by 25 basis points (bps) and hinted that it will likely begin to reduce the size of its balance sheet “at a coming [Fed] meeting.”

Clearly, the recent tightening of global financial conditions since Russia’s invasion of Ukraine has not yet deterred the Federal Reserve (Fed) from sticking to its well-telegraphed intention to gradually remove monetary policy accommodation in response to persistent US inflationary pressures. The Fed also boosted its inflation forecasts, lowered its economic growth forecast, and now projects seven total rate hikes this year (up from three projected hikes as of January).

Geopolitical events could influence monetary policy

I expect the Fed to more or less “look through” the recent volatility of commodity prices (especially oil), unless…

MACRO
Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

Every quarter for the past six years, the Wisdom of Wellington team has surveyed 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 significant shifts in our collective thinking.

At the start of each year, we ask our colleagues which risks they think the market is most complacent about. This can help us to identify areas where the markets are mispricing risk and thus creating opportunities.

The latest survey reveals that the top underappreciated risks for 2022 were China and oil prices over US$100 a barrel, followed by…

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

Archive

We believe 2022 will be the year when macroeconomic and political developments challenge two deep-rooted misperceptions about the euro area:

  • Market assumption 1: the euro area cannot inflate. Our expectation: core inflation will persistently surprise on the upside in 2022.
  • Market assumption 2: the euro area faces persistent structural headwinds. Our expectation: the structural risks of a break-up have faded.

Upside inflation risks

The notion that the euro area is a region of inherently low inflation really took hold after the global financial crisis and was reinforced during the European sovereign debt crisis. In stark contrast to then, monetary policy is currently exceptionally loose, while plans to rein in the pandemic-related fiscal stimulus are far more moderate. At the same time, there is significant pent-up consumer demand, and the industrial cycle should…

MACRO

ARCHIVED

John Butler
John Butler
Macro Strategist
London
Eoin O'Callaghan
Macro Strategist
London

The emerging markets (EM) local debt sector (as measured by the JP Morgan Government Bond Index – Emerging Markets Global Diversified) just posted its worst calendar-year performance since 2013, returning -8.75% against the headwind of higher EM local interest rates. The underlying culprit? EM inflation surprised to the upside in 2021, forcing a number of EM central banks to raise their policy interest rates in an effort to curb the impact.

Although overall EM inflation did not look materially different from that of the developed world last year, the policy response as of this writing has been starkly different: EM central banks as a group have hiked policy rates aggressively, whereas the US Federal Reserve (Fed) and other developed market counterparts have…

MARKETS

ARCHIVED

Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

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…

MACRO

ARCHIVED

Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
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…

MACRO

ARCHIVED

Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

Investor enthusiasm for Japanese equities has long been dampened by the downward trend in the market during the 1990s and 2000s, as well as by structural challenges ranging from deflation to weak corporate governance. But we think this is an opportune time to consider a Japanese equity allocation, as we see seven potential positives that seem underappreciated by the market:

  1. Macroeconomics — recovering from COVID: While we’ll have to keep an eye on the Omicron variant, higher-frequency data suggests the economy has been regaining momentum since the Delta-variant-induced “state of emergency” status was lifted at the end of September. While an economic-surprise indicator for the country is currently very low, we think it has likely troughed.
  2. Monetary policy — benefiting from global inflation: While many developed market countries are struggling with excessively high core inflation (particularly the US), Japan has some way to go before core inflation will require…
MARKETS

ARCHIVED

Daniel Cook
Daniel Cook
CFA
Investment Strategy Analyst
Steven Ye
Steven Ye
CFA
Investment Strategy Analyst
Singapore

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…

MACRO
MARKETS
THEMES

ARCHIVED

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

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…

MACRO

ARCHIVED

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…

MACRO
THEMES

ARCHIVED

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…
MACRO
MARKETS

ARCHIVED

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…
MACRO
MARKETS

ARCHIVED

Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore
Load More
Share on linkedin
Share on email

Categories

Trending posts

DISCLOSURES

Wellington Management Company LLP (WMC) is an independently owned investment adviser registered with the US Securities and Exchange Commission (SEC). WMC is also registered with the US Commodity Futures Trading Commission (CFTC) as a commodity trading advisor (CTA) and serves as a CTA to certain clients including registered commodity pools and their operators. WMC provides commodity trading advice to all other clients in reliance on exemptions from CTA registration. WMC, along with its affiliates (collectively, Wellington Management), provides investment management and investment advisory services to institutions around the world. Located in Boston, Massachusetts, Wellington Management also has offices in Chicago, Illinois; Radnor, Pennsylvania; San Francisco, California; Beijing; Frankfurt; Hong Kong; London; Luxembourg; Singapore; Sydney; Tokyo; Toronto; and Zurich. ■ This material is prepared for, and authorized for internal use by, designated institutional and professional investors and their consultants or for such other use as may be authorized by Wellington Management. This material and/or its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.

In Canada, this material is provided by Wellington Management Canada ULC, a British Columbia unlimited liability company registered in the provinces of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island, Quebec, and Saskatchewan in the categories of Portfolio Manager and Exempt Market Dealer. ■ In Europe (ex. Austria, Germany and Switzerland), this material is provided by Wellington Management International Limited (WMIL), a firm authorized and regulated by the Financial Conduct Authority (FCA) in the UK. This material is directed only at persons (Relevant Persons) who are classified as eligible counterparties or professional clients under the rules of the FCA. This material must not be acted on or relied on by persons who are not Relevant Persons. Any investment or investment service to which this material relates is available only to Relevant Persons and will be engaged in only with Relevant Persons. ■ In Austria and Germany, this material is provided by Wellington Management Europe GmbH, which is authorized and regulated by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). This material is directed only at persons (Relevant Persons) who are classified as eligible counterparties or professional clients under the German Securities Trading Act. This material does not constitute investment advice, a solicitation to invest in financial instruments or information recommending or suggesting an investment strategy within the meaning of Section 85 of the German Securities Trading Act (Wertpapierhandelsgesetz). ■ In Hong Kong, this material is provided to you by Wellington Management Hong Kong Limited (WM Hong Kong), a corporation licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities), Type 2 (dealing in futures contracts), Type 4 (advising on securities), and Type 9 (asset management) regulated activities, on the basis that you are a Professional Investor as defined in the Securities and Futures Ordinance. By accepting this material you acknowledge and agree that this material is provided for your use only and that you will not distribute or otherwise make this material available to any person. ■ In Singapore, this material is provided for your use only by Wellington Management Singapore Pte Ltd (WM Singapore) (Registration Number 201415544E). WM Singapore is regulated by the Monetary Authority of Singapore under a Capital Markets Services Licence to conduct fund management activities and is an exempt financial adviser. By accepting this material you represent that you are a non-retail investor and that you will not copy, distribute or otherwise make this material available to any person. ■ In Australia, Wellington Management Australia Pty Ltd (WM Australia) (ABN 19 167 091 090) has authorized the issue of this material for use solely by wholesale clients (as defined in the Corporations Act 2001). By accepting this material, you acknowledge and agree that this material is provided for your use only and that you will not distribute or otherwise make this material available to any person. Wellington Management Company LLP is exempt from the requirement to hold an Australian financial services licence (AFSL) under the Corporations Act 2001 in respect of financial services provided to wholesale clients in Australia, subject to certain conditions. Financial services provided by Wellington Management Company LLP are regulated by the SEC under the laws and regulatory requirements of the United States, which are different from the laws applying in Australia. ■ In Japan, Wellington Management Japan Pte Ltd (WM Japan) (Registration Number 199504987R) has been registered as a Financial Instruments Firm with registered number: Director General of Kanto Local Finance Bureau (Kin-Sho) Number 428. WM Japan is a member of the Japan Investment Advisers Association (JIAA), the Investment Trusts Association, Japan (ITA) and the Type II Financial Instruments Firms Association (T2FIFA). ■ WMIL, WM Hong Kong, WM Japan, and WM Singapore are also registered as investment advisers with the SEC; however, they will comply with the substantive provisions of the US Investment Advisers Act only with respect to their US clients.

Wellington Management logo

Contact Us

*Mandatory Field

Contact Us

*Mandatory Field