Interview
Rising Yields, Inflation and Risk Assets
- Investors anticipate a near-term inflation spike driven by base effects from the COVID shock, with price prints potentially reaching 2% to 2.25% over the next few months, though this is expected to be limited and not sustained.
- Inflation is projected to normalize to a below-Fed-target range of 1.5% to 2% by 2022, with an inflation regime in 2022 and 2023 not exceeding pre-COVID levels of 1.5% to 1.75% due to productivity gains and globalization.
- The Federal Reserve is expected to maintain an easy monetary policy stance with low rates through 2022 and 2023, aiming to lower the jobless rate from its current 6% to 6.5% range to a target of 3% to 3.5%.
- Policy shifts are not anticipated until 2023, with no rate hikes expected in 2021 or 2022, creating a constructive environment for risk assets and a favorable setting for fixed income.
- A significant increase in government debt issuance is expected to result in an enormous treasury supply entering the market, particularly within the next six months and over the course of the next few months.
- The bond market sell-off is predicted to be short-lived and driven by opportunistic investors, with a reversal anticipated during 2013 and 2014 mirroring the previous taper tantrum, rather than a fundamental bear market in bonds over the next few years.
- The yield curve is expected to steepen as long-end rates reprice to attract marginal buyers, with a breakdown in bond-risk asset correlation expected in the near term before a negative correlation returns.
- Treasury yields reaching 2% later in the year are viewed as a significant buying opportunity, while higher rates are expected to improve pension fund funded status and create demand for longer-dated supply.
- Long-term rates are expected to clear and attract investors in the coming months, potentially supported by equilibrium between pension funds and non-US investors acting as marginal buyers.
- Higher growth and slightly elevated inflation are expected to continue in the immediate future before normalizing to below trend levels, while high growth data from 2020 and 2021 may be extrapolated despite future normalization.
- Default expectations are projected to decline due to a significant economic recovery occurring this year and next, encouraging investors to potentially increase allocations to fixed income, particularly in credit.
- Longer-dated and high-yield municipal bonds are expected to offer substantial value on a tax-adjusted basis, and wage inflation is anticipated to accelerate only after unemployment improves by four percent.
- The current market dynamic is compared to the 2013 taper tantrum, yet the Fed is not currently reacting to rising rates as it did then, and inflation is expected to be insufficient to remain at the Fed's target for more than a month or two.
- Market volatility is expected to return to a low environment with the central bank on hold and moderate rate volatility, while significant money levels are expected to attack fixed income markets.
- An extended period of low rates is predicted to persist despite calls for the end of the bond bull market being premature, as the Fed seeks an economy running hot with inflation at or above target for an extended period.