A “soft landing” as a result of the current monetary hiking cycle is more likely than some doomsayers expect, according to Robert Tipp, who manages almost US$1 trillion of bonds as chief investment strategist and head of global bonds at PGIM Fixed Income.
Noting jobs growth is “incredibly strong” in the United States, Australia and other markets, Tipp said something akin to a “party environment” is playing out in the world’s economies, as it apparently has after previous pandemics.
“After the 1918 Spanish Flu, the 20’s were a roaring decade,” Tipp said, speaking in a panel discussion at Conexus Financial’s Fiduciary Investors Symposium held in June in the Blue Mountains. “After the 1957 global flu epidemic, the 60’s were an incredible decade.” There is also some evidence of a similar phenomena in earlier pandemics, he said.
“You had a big positive impact on growth, and durable upward pressure on wages, and an apparent decrease in peoples’ interest in working,” Tipp said. “In short, it was a consumption party environment that would take place.
“So I think there’s an element of that now manifesting itself in real estate booms and the rapid growth and labour shortages playing out in much of the world. After all of this secular stagnation, it’s hard to imagine that this could persist for a handful of years.”
Noting central bankers in the United States and Europe are “trying to take a balanced approach, and they want the soft landing if they can get it”, Tipp said there were a range of unique problems behind the hard landings seen in recent decades – issues that do not necessarily apply now.
“So I agree it won’t be easy, but overall I think the odds of a soft landing are underestimated,” Tipp said. Inflation, however, may only come down slowly. It could easily be a “half-dozen year kind of episode of high inflation all told, and we are only about a year into it,” he said.
Tipp was speaking in a panel discussion examining the outlook for fixed income assets against the backdrop of escalating geopolitical risks, rising inflation and the glowing influence of climate policy on central bank behaviour.
Hiking interest rates
With market expectations rising for medium and longer term inflation, and central bank forecasts also rising, developing market central banks may act from the emerging market playbook and hike interest rates quickly.
Amy Xie Patrick, head of income strategies at Pendal Group and another speaker on the panel, argued the high inflation levels of developing markets look more like those traditionally seen in emerging markets. “When their inflation forecasts are accelerating like this, it tells you that they are getting less and less comfortable with the inflation that’s turning out all around us,” she said said.
“Now, for 2023, remarkably they still forecast that inflation will return to sort of a normal range, fairly rapidly. And that’s kind of in line with what the markets are pricing in as well. We have some doubts about that. I think the general consensus among the speakers so far today is that we think inflation is going to be higher and a bit stickier than the market currently prices.”
But hiking cycles aren’t always bad news for bonds, she said, presenting data showing inflation-targeting hiking cycles by independent central banks have generally been either benign or even beneficial for bond returns.
“Bonds have a hell of a lot more room to do their job now – of being defensive – than they did at 50 basis points,” she said.
Robert Hogg, head of fixed income and macro research at UniSuper, said the current monetary tightening cycle in Australia was “reasonably well telegraphed” and, as a result, UniSuper had begun to prepare by building cash, and increasing exposure to loans and “other floating-rate sorts of instruments.”
An audience member asked whether central banks would be willing to push economies into recession to stave off inflation.
Hogg said despite having specific inflation targets, central banks also have to monitor the general condition of the macroeconomy in the populations they serve.
“So they’re all balancing it,” Hogg said. “So getting inflation down at the cost of a serious recession, I don’t expect would be a position we’ll find ourselves in, in a modern democracy.”
Another audience member asked to what extent Australia’s housing market and its high levels of housing debt are a “speed limit” for the RBA in tackling inflation.
Xie Patrick said Australia does indeed have to worry more about household debt than the US, with higher levels of household debt compared to income, and mortgages that are predominantly based on a floating rate. But while market predictions of monetary policy “are likely going to be painful for some,” the RBA has shown through reports on financial stability that they are less worried about the housing market than inflation.
“They’ve shown stress tests that shock mortgage rates by over 200 basis points, and still see 40 per cent of households, because they’ve been ahead on their mortgage payments, still not needing to alter the…monthly payments, as a result of that shock,” Xie Patrick said.
“I think…the RBA’s telling you that right now, they have to prioritise inflation…over the housing market, over their concern about house prices falling,” Xie Patrick said. “And that support for house prices cannot be there until they feel like they’ve got a better handle on inflation.”