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Monetary policy

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…

MACRO
MARKETS
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
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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…

MACRO

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

The short answer: yes, in some ways. In a global phenomenon that seems to have gone largely unnoticed until recently, several of my colleagues and I share the view that many developed market (DM) countries are beginning to resemble their emerging market (EM) counterparts in certain respects. We call it the gradual “EM-ification” of DMs.

Does this mean long-standing DM and EM classifications may eventually no longer be relevant? Will investors have to start analyzing DMs through an EM lens? Time will tell, but in the interim, we believe this macro trend bears watching. Let’s take a closer look.

More fragile DM fundamentals

Broadly speaking, it’s fair to say that economic and other fundamentals in DMs have become increasingly fragile over the past decade-plus. During that period, severe stress episodes…

MARKETS
THEMES

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

MACRO

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

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

A key pillar of my largely favorable outlook for China, including potential asset-price outperformance, lies in my directional view on the Chinese yuan (CNY). I continue to believe the CNY is likely to appreciate, or at least remain stable, over the next 12 to 18 months and beyond. Indeed, I think one of China’s challenges over the next few years will be how to contain its ongoing currency strength, rather than how to defend against currency weakness.

Here are the five reasons why I’m still bullish on the CNY.

1. China’s relative interest-rate differential is near the top of its historical range and may stay elevated going forward. For example, the spread between China’s 10-year government bond yield and that of the 10-year US Treasury note was recently at a decade-long high. As a result, I expect Chinese fixed income assets to…

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Santiago Millan headshot
Santiago Millán
CFA
Macro Strategist
Hong Kong

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…

MACRO

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John Butler
John Butler
Macro Strategist
London

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

ARCHIVED

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…

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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…

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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

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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John Butler
John Butler
Macro Strategist
London
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