With long-term horizons for fixed income predicted to remain low, Vimal Gor, head of income and fixed interest at BT Investment Management, and Richard Quin, managing director and head portfolio manager for Bentham Asset Management, present two views on the landscape. Click here to read Quin’s assessment.
The markets are now questioning the ability of central banks to be able to help the world out of the funk it has sat in for nigh on a decade.
The market is moving at a rapid pace towards believing that in the big developed market, central banks just can’t do anything more than they already have to defeat the inevitable slow growth and low inflation environment; which is a symptom of too much debt, poor demographic trends, technological change and worsening wealth inequality. The empirical evidence is clearly with the doubters.
We are also of the belief that the current monetary programmes from the ECB (European Central Bank) or the BoJ (Bank of Japan) will be useless in driving real demand higher, and therefore their economies, to a self-sustaining level. This may seem odd as we have been strongly advocating for the past five years that central banks need to ease policy harder and faster and buy bonds to force down real interest rates and ease financial conditions for these troubled economies. We weren’t arguing for this because we thought it would solve all the issues the global economy has, but because:
1 / It couldn’t hurt when demand is clearly lagging
2 / It would be much worse if everyone didn’t ease as much as they had
3 / Sadly, it was the only option everyone had because in the developed world fiscal policy surely wasn’t going to pick up the slack.
It’s all in the timing
In our view, fundamental drivers were always going to force bond yields much lower, but the issue was one of timing. The longer this took, the more damage would have been done to the confidence of consumers and the confidence of the market. A market with poor confidence is prone to financial crises, which throughout history have caused recessions and even depressions.
The losses from US housing were far too high for monetary policy to avoid the confidence issues with the US banking system, but in this instance it was the Federal Reserve acting as lender of last resort (ex-Lehman, of course). Central banks are important institutions that used to fulfil the role of defending the financial system from collapse. If they are now shooting blanks, who’s left to perform the role?
In this environment of low and/or negative interest rates, a related issue is that the search for yield has seen investors taking on more risk. The resulting mismatch in liquidity profiles between funds/ETFs and underlying securities will be highlighted if and when investors start to redeem en masse.
We now couple this with the start of what we believe will be a rising default cycle – not just commodity-related companies, but across a range of sectors.
The combination of significant growth in credit markets, increasing susceptibility to retail flows, and shrinking dealer balance sheets has created a problematic liquidity backdrop.
This did not matter much when volatility was low and the Fed was easing aggressively. Liquidity is not a problem until you need it in a big way, but the vulnerabilities are slowly but surely being exposed.
Gor and Quin will be presenting at the Fixed Income, Cash and Currency Forum in Melbourne on July 26 – 27. To register for the event click here.
