Interview
Rising Yields, Inflation and Risk Assets
- Fixed income global portfolio management oversees over $700 billion in assets.
- Recent sharp rises in treasury yields are primarily driven by investor concerns regarding significant economic recovery, substantial government debt issuance, and subsequent inflation spikes.
- A parallel is drawn between current market dynamics and the 2013 "taper tantrum," where Fed signals of reducing bond purchases triggered a market sell-off.
- Unlike 2013, the current Fed is not actively reacting to rising rates to tighten policy, suggesting the current volatility may be short-lived.
- The current rise in rates has predominantly impacted the fixed income market, with early signs of stress beginning to appear in equity markets.
- The Fed's current monetary stance aims to keep money "easy" through 2022 as growth and inflation normalize post-COVID.
- Investors are currently over-extrapolating growth and inflation forecasts based on 2020's deflated price base, whereas the outlook suggests normalization to below-trend inflation.
- The Fed is explicitly targeting full employment at a 3% to 3.5% unemployment rate, whereas current levels stand between 6% and 6.5%.
- A key shift in Fed policy emphasizes "quality of employment," seeking wage inflation and workforce participation rather than merely filling jobs with low-paying positions.
- Based on current employment gaps, the speaker anticipates no policy rate changes in 2021 and none likely until 2023.
- New fiscal stimulus is creating enormous Treasury supply that requires repricing the long end of the yield curve to attract marginal buyers.
- Pension funds are expected to act as significant demand sources for longer-dated assets, as rising yields and yield curve steepening have dramatically improved their funded status.
- Inflation is projected to resume a trajectory of 1.5% to 2% by 2022, below the Fed's target, rather than triggering a high-inflation regime.
- Bond and equity correlations, which recently broke down, are expected to return to their historical negative correlation in the long term, with bonds serving as portfolio ballast.
- Investors are advised to maintain or marginally increase fixed income allocations, particularly in credit assets where default risk is anticipated to decrease.
- Longer-dated and high-yield municipal bonds are identified as offering significant value on a tax-adjusted basis.
- The speaker argues that pre-COVID inflation levels were approximately 1.5% to 1.75%, and there is no evidence to suggest a worse inflation regime in 2022–2023.
- Global productivity gains driven by technology and the flexibility of global supply chains are cited as structural factors preventing sustained high inflation.
- Treasury yields reaching 2% to 2.25% on the 10-year bond are viewed as a significant buying opportunity rather than a signal of a bear market.