The great central bank monetary policy experiment that has led to enduring low and negative interest rates for the first time in the bond market’s 400 year history will reach a inevitably reach a crescendo, but what this crescendo looks like and the ultimate impact it has on investors still remains unclear.
Central banks, governments and their ability to normalise the very policies they have put in place and their side-effects is critical to restoring will be critical to the proper allocation of scarce capital in the future as well as critical to preserving capital that already supports valuations in all asset classes, Jay Sivapalan (main picture, right), head of fixed interest at Janus Henderson said during Investment Magazine’s Fixed Income & Credit Forum in late March.
“Only time will tell whether this can be done successfully,” Sivapalan said, noting policy makers’ desire to smooth out the boom/bust investment cycles of the past, stamp out the inflationary pressures of the 70s and 80s and to ignite economic growth through the last few downturns.
“I’m not a doom and gloom merchant myself and am willing to back policy makers but there are practical measures asset owners and investors can undertake today to prepare portfolios for the market path forward and also some cheap insurance should central banks not be successful,” he said, noting that all asset valuations as well as future economic growth so desperately rely on this financial stability.
There will be a limit to the support central banks can provide to economies and markets, Sivapalan said, but this limit will only be known after it is reached, he added.
What happens during the unwinding of central bank policy is uncertain but presents a good opportunity for fixed income investors with a global perspective, according to Pilar Gomez-Bravo (main picture, left), director of fixed income – Europe, MFS.
Gomez-Bravo pointed to the dispersion and volatility that’s likely to occur as inflation inevitably rises and central banks around the world address low rates at different times.
“If you appreciate countries are going to exit in different ways so you have different yield curves to trade off and pair with, I am super excited because I know I am going to see dispersion, I’m going to see volatility,” she says is a separate session during the forum on the topic of the impact of QE on the defensiveness of bonds.
“We have a been in a very synchronised global rates move and, guess what, every country is going to have to come out of this in a very different way,” she said.
On the question of inflation materialising, Gomez-Bravo pointed to likely higher levels of inflation in the near term, which could mean maybe towards the end of the year due to “demand pull factors that are led by supply constraints and huge amounts of savings that are going to be spent as economies open up,” she explained.
On the broader topic of inflation, Gomez-Bravo highlighted that the “nagging fear” regarding the topic has to do with the underlying belief that perhaps all this central bank stimulus is not really needed.
“Remember the stimulus we have seen is the highest since the world war but we haven’t destroyed capacity like we did during the world war. During the GFC we had destruction of balance sheets at the banks but this time around we haven’t had that…If we don’t have the destruction of capacity and lending capacity in the extreme cases we have seen before there is a big question mark [whether we need this level of stimulus now,” she said.
In thinking about and predicting what are the limits of central bank support, Janus Henderson’s Sivapalan encouraged investors to consider some of the following factors, including: the confidence central banks have to keep experimenting with policy, when and whether markets stop becoming free markets, whether governments are bound by ultimately having to pay for the debt, and whether on the private capital side whether there is ongoing confidence to invest.