Fixed Income Investing: Even More Difficult Than Usual

Alastair Winter

(Hay una versión en español de este artículo aquí.)

Alastair here writing from London.

The latest CPI number in the US gave rise to a flood of alarmist press coverage last week. The inevitable eventual let-up in the stream of dreadful inflation numbers is being pushed further forward in 2022 and even into 2023. Although it does, indeed, seem, inflation will remain ‘elevated’ for longer than many expected, the market has concluded that most central banks have now determined to hike even faster and earlier in order to choke off inflation.  

A series of further 75bp Fed hikes is expected.   

The ECB has promised at least a 25bp hike on July 21st and may yet double up to end its negative rates policy after eight years, which the Riksbank may front-run at its next meeting on July 30.  

The central banks of Australia, Brazil, India, and (surprise!) Switzerland have joined the Fed and Bank of England in hiking in June while those in Mexico and Indonesia will do so before the end of the month. Considerable doubt, however, surrounds both the pace and peak of UK rates as the Bank of England is rightly concerned about recession and Governor Bailey seems more open than his predecessors to political pressures.  

The Bank of Korea may well also be reluctant to hike beyond the 3% level while the Bank of Japan has a real fight on its hands to defend its 0% target for the yield on a 10-year Japanese Government Bond. 

 The likelihood of more aggressive central bank decisions is what has spooked markets into believing that recession is probable in many economies, now including the US as well as the UK and the Euro Area. Central banks will, nevertheless, be anxious to avoid making any recession worse, albeit that most say they hope to avoid it altogether, by further constraining demand through ‘excessive’ rate hikes. As a result, the market is perfectly capable of concluding that rates will not be hiked by quite as much as it currently fears. This could well mean that either some central banks hold back or, having hiked hard, start soon cutting rates again. In any case, even the higher peak levels are hardly ‘Volckeresque’. 

This, of course, makes investing in Fixed Income even more difficult than usual, especially in shorter dates, in currencies other than the dollar and in riskier credits (whether or not USD-denominated). Many institutional investors are already being tempted to settle for investment grade USD bonds with longer duration and that may well lead to a feed-back loop on expectations for central bank hikes.  

Simple, really!