Central banks are unlikely to “hike like mad and… cause a disaster” but will probably keep interest rates relatively high for a longer period than markets currently expect, according to Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income.
Predicting a soft landing rather than a recession, Tipp said lower rate volatility will likely see corporate spreads narrow while long-term investors will look at the highest rates they have seen in 20 years and begin to conclude bonds are attractive investments.
Speaking at Investment Magazine‘s Fiduciary Investors Symposium in a session looking at rapid interest rate rises and the implications for long-dated, low coupon bonds, Tipp said the world had enjoyed a great disinflationary period for decades on the back of factors such as increased globalisation and the rise of China.
This period has been replaced by the “party environment” following the pandemic where some analysis suggests a significant portion of stimulus has yet to be spent, leading to an inflationary environment. Capital expenditure and lower efficiency associated with “friend-shoring” – owing to a tense geopolitical climate – are also inflationary pressures, he said.
The primary concern of central bankers is now “they would take their foot off the brake too soon and that inflation would become a more ingrained problem and even more difficult to get down,” Tipp said.
“I think you’re going to have a very tight range on rates,” he said. “Even if things slow down, inflation begins to moderate, I think it’s going to be very hard for them to drop rates much, which means the volatility on rates is going to go down in this paradigm as we go forward.”
Also speaking on the panel was Jonathan Armitage, chief investment officer at Colonial First State who pointed to research suggesting if inflation hits 6 per cent, it can take between five and seven years to return to 2 per cent levels, and longer if inflation goes above 8 per cent.
Inflation to take a lot longer to ease
“I think the thing that markets are going to have to start grappling with is the trajectory down to where central banks currently are mandated to get inflation down to,” Armitage said. “I think that’s going to take a lot longer than people expect. Either that or central banks will change their inflation rates.”
Robert Hogg, head of fixed income and macro research at UniSuper, noted the global economy has “continued to really surprise almost everybody on the upside”.
“We continue to be confounded with the strength of employment, we continue to be confounded with the breadth and the height of inflation,” Hogg said.
The longer markets live with higher inflation and the more attuned people become to this paradigm, “that’s the kind of background that really locks in these higher inflation rates,” Hogg said. “So the central banks have a tremendously difficult task.”
Noting long-term deflationary forces are now reversing, he said he is “probably more in the camp that thinks inflationary pressures are going to be more sustained”.
However his outlook on the economy was more bleak than Tipp’s. While a recession has not arrived yet, the impact of rate rises may finally hit economies later this year, and this will coincide with consumers in developed economies running out of the cash balance they stored up after the pandemic, Hogg said.
“That combination with a massive slowdown in consumption, coupled with the… full force of rate rises coming through, I think bodes ill for global economies in the latter part of this year,” he said.