Partner Content: Kerry Duffain from Fidante Partners on the role of the Bank of England, Fed and European Central Bank in responding to inflation and the relative-value alternatives for navigating turbulent interest rate markets.
The weight of evidence suggests that inflation this year is likely to be more persistent than everyone had hoped for. When we first started to see increases in inflation, much of it was from consumer goods. More recently, however, we have started to see significant contributions to overall inflation coming from services.
Services are not restricted by the same constraints that caused inflation in consumer goods and are driven by different factors – mainly wages – which is causing concern.
Central banks, especially the Fed, have a poor record of controlling inflation, so will they manage it this time and how?
Back in November 2021, the Bank of England (BoE) failed to raise interest rates after it had steered markets to expect an increase. However, in December it did raise rates, surprising investors and making the UK the first large, wealthy economy to experience interest rate rises since the pandemic struck.
The problem the Fed had most recently was that inflation was too low, but now it is potentially too high. All the supply-side constraints and bottlenecks are acting as a speed limit on economic activity. This means the Fed doesn’t have as much leeway when it comes to its timing cycle, and there is also a much greater risk if it steps on the brakes too much and hikes interest rates too quickly.
The European Central Bank (ECB) needs to tread more carefully than the Fed when it comes to stopping bond purchases and the implications of that for markets and macro outcomes. It is likely that it will take a lot longer before we see genuine reductions in the ECB’s balance sheet – it is committed to a longer period of reinvesting coupons.
The path to tighter monetary policy is a longer and more winding road for Europe. And this has implications for how European yield curves will trade relative to the US.
Central banks, especially the Fed, have a poor record of controlling inflation, so will they manage it this time and how?
Relative-value alternatives
The macro backdrop presents significant challenges for treasury managers seeking reliable, low-volatility returns from fixed income. Simply buying and holding bonds means greater risk of capital losses if inflation pressures persist and the BoE remains skittish. Even if inflation pressures do subside, the path for yields is likely to be anything but a straight line.
What will be more interesting for investors is the non-traditional sources of return – namely the absolute-return and relative-value spaces, or other types of non-traditional fixed income. Some of these alternative-return sources can be a good way to help tide things over as they tend to keep working regardless of the level of yields.
Kerry Duffain, Institutional Client Solutions, Fidante Partners.
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