Inflation is the key focus for major central banks, as the view of its ‘transitory’ nature falls out of the consensus to be replaced by an expectation that it will be a significant and long-lasting problem. Our reading of the situation is that inflation has become at least as much a political policy issue as it is an economic one and, for all that some central banks are nominally independent their governors are well aware which way the winds of political opinion are blowing. Faced with potential stagflation, it’s our view that central banks have chosen to target lower inflation over stimulating growth.
Most important for global fixed income markets, of course, is the approach taken by the US Federal Reserve (Fed), which now seems determined to return real rates (base interest rates minus core inflation) to positive territory. For that reason, the further six hikes in US rates – on top of the one already announced – that the Fed is currently guiding for seems plausible, and in any event our central thesis is that US interest rates will move significantly higher across the curve over the next 12-18 months.
Our team’s fixed income alternatives strategy is able to use a traditional range of fixed income exposures, but with the added dimension that we have the ability to go long or short in any of them at a given time. Within these broad parameters there are many ways that alpha could conceivably be generated, but at the moment we see the big call on the direction of rates as the key call investors need to get right. Our own approach has been to go short duration, given our views on the likely path of rates, although clearly that view is vulnerable to any major ‘risk-off’ move in equities that could spark a reach for yield. As a partial hedge against that we are also long USD, which we also like on fundamental grounds given the potentially unbalanced mix of growth across the world over the remainder of this year.
Finally, commodity prices have undoubtedly been strong and in our estimation the world has moved into a macro environment where the security of commodity supply lines, as much as the price of those commodities, is a primary focus for governments around the world. So the currencies of any country that is primarily a commodity exporter – for example Australia or Indonesia – looks to us like offering attractive diversification potential.
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