As global interest rates show early signs of topping or ‘rolling over’, asset managers are warning that the longer-term outlook has flipped from ‘lower for longer’ as experienced for more than a decade post-GFC, to ‘higher for longer’. “In our five-year outlook, we are putting higher inflation rates in on average over the next five years than you have seen over the last five years, or indeed the last 25 years,” said Colin Graham, Head of Multi Asset Strategies at Robeco, during a recent Momentum Investments webinar.
Cyclical versus structural…
Graham was responding to a question put to him by Momentum Investments’ CIO, Mike Adsetts, over whether the current high inflation, high interest rates environment was a cyclical or structural phenomenon. Robeco, a Netherlands-based international asset manager, also warned of greater volatility around economic growth, especially if the United States (US) economy were to enter recession, as many economists now expect, and most US leading economic indicators now signal with near-certainty. The two-way discussion focused on the short-term return outlook for various asset classes, starting with the fixed income complex, that was, according to Adsetts, becoming far more investible.
“From a global perspective, what is your thinking in terms of the risk and opportunity associated with different asset classes, midway through 2023?” he asked. Graham responded that the consensus view on US inflation returning to the central bank’s 2% target seemed optimistic, and would create opportunities. “This means that cash rates will no longer be zero; we have moved from a TINA world, where there were no alternatives to equities, to one where there are reasonable alternatives,” he said.
Case in point, the yield on offer at the long-end of the bond curve would likely be 200 basis points higher than anticipated. The caveat, fixed income and multi-asset fund managers need a clear view on US inflation over 12-months and longer. If US inflation goes to 3%, the value argument for bonds evaporates. Commenting in the context of relatively stable US inflation, Graham added: “We want to invest in bonds when we [are confident in] the global economic … and that rates will be cut into the future”. The inverted yield curve, which saw short-dated bonds offering much higher yields than long-dated bonds also offered alternatives to equities. “There are many alternatives to equities, mostly in cash and short-dated bonds,” he said.
Equity market ‘tipping point’ looms
The equity view is a bit more complex, because although there is currently support for this asset class due to high nominal economic growth, there will be a tipping point when higher interest rates finally ‘bite, the US economy slows, and corporate earnings come under pressure. Robeco has already responded to this likelihood by taking defensive positions in its multi-asset portfolios, and being overall underweight equities. “We are overweight emerging versus developed market equities, based on relative valuations, but also [due to] the fact EMs have more room to cut interest rates, whether it be Latin America, or indeed, China,” Graham said.
One cannot have an asset allocation discussion these days without considering whether or not the world’s largest economy is headed for recession. “An inverted yield curve is invariably an indicator of recession, but with the US job numbers showing resilience, it seems like we are not quite getting there,” said Adsetts, going on a bit of a fishing expedition. Many global asset managers and equity analysts had expected the US to be in recession already, certainly by the halfway point of 2023. However, fiscal and monetary policy interference, such as the central bank propping up regional banks earlier in the year, had provided enough liquidity to delay the inevitable.
Graham said that liquidity was a key indicator to watch. “Once liquidity dries up, there is less push into the riskier end of the investment spectrum,” he said, meaning equities and other riskier asset classes would become less attractive. There were a number of structural supports for the US economy presently, including high employment and that fact that US mortgage holders are less impacted by higher interest rates than their peers in other developed markets. The reason for this is that many US homeowners are sitting in fixed-interest mortgages at just 1.5%.
“In our view, the US Federal Reserve will have to do more [to combat inflation],” Graham said. How much more? Well, Jamie Dimon, the Head of JP Morgan, recently said that US rates would have to go to 7%, from around 5.25% currently.
Alternative markets not that clear cut
High interest rates have substantial impact on alternative asset classes that rely on gearing. “A lot of the different asset classes and investment types within the alternative complex have relied on low interest rates … more specifically private equity and gearing in property,” Adsetts said, before asking about Graham’s view on the sustainability of investment opportunities in alternative markets. Graham admitted that private debt and private equity had been among “the biggest beneficiaries of zero interest rates, loose monetary policy and plentiful liquidity”. It makes sense, however, to steer clear of these ‘geared’ investments today. In contrast, infrastructure projects that offer inflation-linked returns are looking attractive again.
The Chinese economy is always a feature of globally focused multi-asset fund asset class decision making. Adsetts contended that the Chinese economy was too big to “realistically sustain its [historic] high levels of growth” and that its challenger status on the global stage introduced significant geopolitical risk. “We have never subscribed to the US rhetoric around China being un-investible; of course, it is investible,” Graham said. He argued that investing alongside government in infrastructure projects was generally a safe bet, whether you were doing so in China, Europe, South Africa or the US. But his final comment on China’s growth prospects really hit home: “If China’s growth rate come down to 3% per annum for the next decade, that is the equivalent of adding India to the global economy”.
The reserve currency conundrum
The dollar was incredibly strong midway through 2023, hitting four-year highs against the Euro. Despite this, the dollar’s status as global reserve currency is more tenuous than at any time in the last few decades. “The dollar is going to struggle to [remain] the reserve currency because the US has weaponised it [through] sanctions, in terms of not allowing people to trade … so, we are seeing countries trying to circumvent this,” Graham said. Case in point, many large cross-border oil transactions are being written in Yuan instead of dollars.
The dollar should weaken from current levels,but is unlikely to lose its global reserve currency status in the next five- to 10-years. The closing ‘clip’ from the debate left the audience with plenty to contemplate, namely whether the global reserve currency concept would survive the emergence of digital currencies like Bitcoin and Ether. Who knows what global currency and payment systems look like a decade or so into the future!
Writer’s thoughts:
I must confess to being a bit jaded by the inflation, interest rate and US recession themes in most of the asset manager / economic presentations I have attended recently. Are you, like me, rolling your every time these topics appear on the agenda? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za
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Added by Ingrid Denzin, 17 Aug 2023