Markets are looking through macro-economic uncertainties to the “other side of the pandemic” where the economy is going to be in reasonable shape, says Nathan Sheets, chief economist and head of global macroeconomic research at global active fixed income manager PGIM Fixed Income.
Central banks had been active not only in supporting markets but in creating an “implied backstop” where markets believe central banks will respond with greater support if there is another market shock, Sheets told the Investment Magazine Fiduciary Investors Symposium held online on November 17 and 18.
Hopefully markets have got it right, he said.
“In times past, markets have proven to be quite forward looking and trenchant in that forward looking view,” Sheets said.
“The question I think is: is this time different? And maybe one way it’s different is it’s not really as [much of a] macro situation, it’s more public health and a situation with the virus. Are the markets getting it right? That’s a question I think about every day.” Watch a brief excerpt of the interview with Sheets below.
But the macro economic environment after the pandemic is likely to be challenging, and central banks will struggle to incentivise stronger growth in the medium term, he said.
“Central banks can inject liquidity into system but then banks have to lend it,” Sheets said. “And even if the banks lend it then the firms and individuals have to be willing to spend it.”
Fiscal policy levers may also face political hurdles, he said.
“In the US there’s a case for more infrastructure, there’s a case for green investment to adapt to the realities of climate change,” Sheets said. “But in order for that to happen you have to get a Republican-controlled senate to agree with Biden who is a Democrat. The probability we will see much progress on that over the next two years is pretty low.”
When asked what he saw as the biggest risk for inflation, Sheets said he believed low inflation would be one of the key characteristics of the challenging macro economic environment that lies ahead, due largely to the ageing population leading to weaker aggregate demand.
“I just think we are in a place where inflation is dormant and central banks are going to work, and maybe central banks will be successful over time but it’s going to be a challenge for them to get back to their inflation objectives.”
In a low rate world, the global search for yield would push investors to “reach a little bit more out of the credit curve and take on a bit more risk”, he said.
“The implications of that is risk assets will do well. I think that includes emerging market debt in the credit space, high yield and various investment grade opportunities in the corporate bond space. And I think there’s also a strong case for equities and particularly thinking about equities for yield, there are a lot of stocks that have very attractive yields relative to what you can earn in the bond market. So I think this is going to be a search for yield environment where credit spreads likely to grind lower, say, over next five years.”
When asked whether he thought Jerome Powell would be retained as chair of the Federal Reserve, Sheets said he would “put a coin flip on it.”
“One of the great ironies is that Chairman Powell was appointed by President Trump and his probabilities of being reappointed are significantly higher with a President Biden than had President Trump been re-elected,” Sheets said.
“My view is that whoever is at the Fed, monetary policy is likely to remain quite stimulative. And I think rates in the United States will be very low for years to come.
This would likely see the US dollar driven lower, although the challenge was figuring out which currency this would be against, and what the timing would look like, he said.
You can see the full interview with Nathan Sheets on the Fiduciary Investors Symposium digital hub.