The odds of a “soft landing” from the current high-inflation environment are “higher than most people think,” according to Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income, predicting inflation will decelerate but remain above the US Federal Reserve’s inflation target.
“It wouldn’t surprise me if [The Fed switches] to 25 basis points per meeting after the December meeting,” but the Fed can still “do a lot of damage” next year even with smaller rate increases said Tipp. With the federal funds rate nearing 4.4 per cent, “it’s going to be difficult for the 10-year treasury to stay below 4 per cent,” he said.
Tipp was speaking at the Investment Magazine Fiduciary Investors’ Symposium held at Healesville, in a session titled: ‘Bond market status: High alert, buying opportunity or both?’ PGIM manages US$790 billion of fixed income.
Prolonged low rates
The period of extremely low interest rates from 2010 onwards saw central banks “creating an incredibly unwholesome environment for developed economies,” Tipp said, by keeping asset prices high, making housing unaffordable, and discouraging savings.
“Around the world in developed economies, we have ageing societies that need to increase savings,” Tipp said. “And for anybody that was going to retire and want an income, they would need to save even more in order to get to that point.”
Markets are out of that, thankfully, he said, with robust growth taking place in the Covid recovery period, and impressive growth in jobs. Acknowledging it is difficult to make a call on whether a “hard landing” or a “soft landing” will take place, Tipp said in his view a soft landing was more likely.
“There’s not a lot of data on central banks achieving soft landings from very high inflation, but there are not a lot of episodes of very high inflation,” Tipp said. “And I think the central banks have learned a lot in recent decades and have achieved more soft landings than generally appreciated, like 1994 to 1995, and even as recently 2018 to 2019.”
Most hard landings have occurred against a backdrop of underlying problems in the economy, such as over-investment, over-leveraging, widespread accounting fraud, or some combination, he said.
“Right now, I think we have a pretty clean picture compared to those hard landing environments,” Tipp said. “I think the odds of a soft landing are higher than most people think.”
He predicted inflation over the intermediate term will decelerate “towards target but not quite get there”.
“I think most key components of inflation look like they’re going to be coming away from the red zone and, within a year be down in the amber zone and moving towards the green zone,” Tipp said.
Tipp said even if inflation falls significantly to three per cent per annum, “I don’t think the central banks are going to be ecstatic given the nearly record low unemployment. I don’t think they’re going to be cutting interest rates especially against a full employment and an ongoing economic expansion.”
Warning against “overreach” on the part of central banks to control the secular outlook through monetary policy, he hoped instead central banks would realise the better economic outcomes to come from having rates at three to five per cent, which encourages savings and discourages overleveraging.
“The only way to actually improve people’s welfare is by allowing interest rates to stay up at market levels – and not by encouraging borrowing at unnaturally low rates of interest. Higher savings provides more capital for investment,” Tipp said. “After all, investment, and the resulting higher productivity is really the key to improving welfare.”
Higher rates would also keep fixed income “in the spotlight as an asset class” with a “favourable correlation balance between risk assets and bonds,” he said.