Taming stubborn inflation is proving to be a Herculean task for policy makers. That in turn is making reading the direction of the fixed income markets extremely difficult for investors. There’s been little respite from volatility in fixed income this year too unlike other asset classes.

In the beginning of this year, fixed income markets had a bullish overtone as they expected a slowdown in growth to ease inflationary pressures, enabling central banks to row back from their aggressive policy stance. US activity data remained strong though, and it was not until the collapse of Silicon Valley Bank that markets were convinced that the US Federal Reserve was fast approaching the end of its peak rates.

However, core inflation has stayed at elevated levels due to an imbalance between demand and supply. The personal consumption expenditures price index, the Fed’s favourite inflation gauge, is still more than twice the central bank’s target. The supply chain constraints faced during the pandemic and the geopolitical fault lines are forcing economies to rethink the prudence of relying on globalisation that had taken hold over the last three decades. This could mean lower efficiency and higher costs. The bar to generate inflation is now lower as even a slight increase in demand spurs inflation.

Tight labour markets

The tightness of the labour markets has compounded the problem, with the rise in salaries to compensate for inflation further fuelling price pressures. In the US, while average hourly earnings and unemployment rate are showing early signs of softening, the headline nonfarm payroll numbers have surprised to the upside for 14 consecutive months. While big technology and finance companies have announced job cuts, they are not representative of the pulse of the wider economy.

Economies are holding up relatively well despite the Fed’s full five percentage points rate increase since March 2022. We believe the resiliency of the economy means expectations of rate cuts won’t be met until next year. Since there are no widespread job losses, meeting everyday expenses or paying mortgages aren’t posing problems although disposable incomes have fallen. While inflation seemed to dictate the pace of rate increases, the labour market is a deciding factor on the peak level.

In our view, the labour market holds the key to everything. That’s what will decide how the current rate hiking cycle ends as factors such as wage growth, inflation, housing prices and overall demand in the economy are all linked to the job market. A strong labour market therefore leaves us unsure on developed market bonds for now, but if the recent rise in US initial claims continues then US duration suddenly looks very attractive.

Hawkish pause

After 10 successive increases since March 2022, the Fed skipped raising rates for the first time in June, with a caveat that there is room for more hikes. For now, the Fed is assessing the lagged effect of the policy rate increases so far, while keeping a close eye on data and how the banking turmoil evolves. The central bank has also signalled that two more rate hikes could be in the offing. Other monetary policy authorities such as the European Central Bank (ECB) and the Bank of England (BOE) have also been raising rates aggressively to tackle high inflation.

At this stage, it appears as though central banks are keen to pause and wait to study the result of their actions so far. Their messaging has been consistent in this regard, with the Fed, the BOE and the ECB all confirming that they are now at or approaching their terminal rate – a level which is deemed sufficiently restrictive to wait and see how inflation behaves. If anything, they are more concerned with market pricing of rate cuts and have spoken a great deal about their ‘higher for longer’ stance.

Front end bears the brunt

Given the unprecedented pace of rate increases, the front-end of the yield curve has faced elevated volatility. The yield on the two-year Treasury note has surged about 300 basis points since last March to 4.7 percent. While yields retraced in March as US banking woes came to light, they have once again risen. Markets believe that previous tightening will be enough, a fact reflected in the flattening of yield curves and market pricing of inflation. That said, this all hinges on labour market data, especially in the US.

Taking a high conviction view in this environment is challenging as the path towards an eventual rate cut may not be linear. A Goldilocks scenario of slower growth containing inflation and in turn spurring rate cuts this year seem to have been pushed much farther than expected earlier this year. Until inflation falls to acceptable levels, interest rates will remain elevated, which means positioning will continue to be on a knife’s edge. In this context, staying low duration and being flexible may help in overcoming any near-term challenges.

Please fill in your details to subscribe to Jupiter’s newsletter.

This interest sign-up form is strictly for Professional or Institutional investor only. Please be informed that by submitting this form, you confirmed that you are a Professional or Institutional investor. Jupiter Asset Management reserves the right, with or without notice to remove you from the list if you are not a Professional or Institutional investor.

The value of active minds: independent thinking

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

Important information

This communication is intended for investment professionals* and is not for the use or benefit of other persons, including retail investors.

This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.

The views expressed are those of the Fund Managers at the time of writing and are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.

Issued in the UK by Jupiter Asset Management Limited, registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A. (JAMI), registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier. Issued in Hong Kong by Jupiter Asset Management (Hong Kong) Limited (JAM HK) and has not been reviewed by the Securities and Futures Commission.

No part of this commentary may be reproduced in any manner without the prior permission of JAM, JAMI or JAM HK.

*In Hong Kong, investment professionals refer to Professional Investors as defined under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong).and in Singapore, Institutional Investors as defined under Section 304 of the Securities and Futures Act, Chapter 289 of Singapore.
29395