Strategic Fixed Income – The Turn of the Global Liquidity Cycle
In the latest video from our Strategic Fixed Income Team, Co-Head Jenna Barnard explains how the team has viewed the bond markets through the prism of interest rate divergence for a number of years now.
- There is a clear divergence in interest rate policies within the developed markets, with the U.S. Federal Reserve standing alone from the pack
- As a consequence of the monetary policy divergence, U.S. dollar strength is driving a series of liquidity events
- The Strategic Fixed Income Team views the pressures in the financial markets this year as linked, due to the “liquidity withdrawal environment,” and not idiosyncratic, as many believe
- The uptick in inflation is, in their view, cyclical and not structural
Today is Tuesday the 19th of June and I wanted to provide investors with an update on how we are thinking about bond markets. The first thing to say is that the key theme for us for many years has been one of interest rate divergence. So although the Fed has pushed on with this rate hiking cycle, most central banks have struggled to raise rates a little bit or at all. And Australia is a great example of that where the central bank is weighed down by low inflation, low wage inflation and a housing market that has peaked and is deflating quite rapidly. Canada has some of those parallels, but they have high interest rates. And the UK is obviously a great example of a central bank that has flip- flopped on its ability to raise interest rates.
Mario Draghi at the ECB last week, I think, really highlighted this divergence via his forward guidance in terms of when they would begin hiking interest rates. And that in itself has also impacted the currency market and the strength of the U.S. dollar. I think that currency strength is something that we are very alert to and the reason we are alert to the impact of the strengthening U.S. dollar is the impact it has on liquidity conditions. 2018, for us, has felt like a liquidity withdrawal environment. We don’t view the events of February and the volatility episode in equity markets, the events in emerging markets and the widening in traditional credit spreads is idiosyncratic. We think they are connected and they suggest, as I said, a more systemic issue relating to withdrawal of liquidity. The U.S. dollar feeds into that because there is a huge offshore dollar economy with so many borrowing U.S. dollars, which isn’t their home currency.
So for John and myself, we think markets are an inflection point right here in June. The bond hysteria and bond bear hysteria about inflation, we think, was misplaced. It was cyclical, not structural. And actually, U.S. inflation should be peaking in the coming months. Elsewhere in the world there is very little sign of any shift in inflation upwards and wage inflation continues to mystify central banks and economists. For that reason, given the repricing in government bond markets, we think it is a very opportune time to add government bond duration and to be cautious on the outlook for risk assets, particularly in the credit market.