Official interest rates will rise but it was “way too early” to move to overweight in fixed income assets said Katie Dean, the head of fixed income, currency and cash at Australia’s largest fixed income allocator, AustralianSuper.
“What I really struggle with is in terms of what the market is pricing,’’ Dean told Investment Magazine’s Fixed Income and Private Credit Forum.
“(it suggests) The (US) Fed funds rate will peak at two to three per cent and inflation will magically come back down to 2.5 per cent in the next two and a half years; one of those is not right,” she said.
“Either we have higher inflation for longer or the Fed is going to have to do a lot more.”
On fast forward
Dean is hesitant to move overweight to fixed income but said the cycle was “on fast forward”.
“The time to do that is when the 10-year yield reaches where the maximum (US) Fed Fund will be (not 2.5 per cent),’’ she said.
Dean described a number of “black swan events” driving the inflation turning point, and potential to break secular stagnation, a once discredited 1930s theory revived in 2013 by former US treasury secretary Larry Summers who argued it was hard to boost economic growth by lowering interest rates.
Inflationary events began with the rise of populism and the election of US President Donald Trump in 2016 and his promotion of deglobalisation, then pro-cyclical stimulatory fiscal policy which gave inflation a chance to rise in the US, she said.
Perfect inflation conditions
The pandemic and stimulatory fiscal policy averted a massive demand shock at the same time perfect inflation conditions aligned through a supply shock, a shortage of labour, closed borders and supply chain concerns, she said.
“Put all those together and it’s an easy conclusion to make. Inflation was always going to go higher, and this was the once-in-a-generation chance to break out of secular stagnation,’’ Dean said.
For investors, the time to move most underweight in fixed income allocations was when official rates troughed in December 2020.
“Now the question for AustralianSuper, and other asset allocations moving through the cycle, is: ‘when do we reduce that underweight to fixed income and when do we start to buy fixed income and move to overweight fixed income again?’,’’ she said.
“We want to manage our fixed interest exposure through the cycle so that it’s adding maximum value for our members.”
While Dean had a “massive list” of what AustralianSuper did not want to own, the fund had active levers to manage duration and currency exposures and was able to allocate to sectors within fixed income.
She said now was not the time to be adding private credit to portfolios or moving towards illiquid credit or mid-risk style assets.
“As a large fund with a long-term investment horizon, we’ve got plenty of appetite for illiquidity, but we want to be paid for it and actively manage it through the cycle and something we look to allocate to higher investment returns,” she said.
“In terms of illiquidity, I don’t think the returns are as strong as other assets we’re looking at.”