Isobel Lee has seen some of the toughest fixed income markets from the end of the Cold War to the global financial crisis, and she has two words for those trying to navigate a messy global exit from the pandemic. : “Be humble. “
“We are aware that this is an unprecedented situation – none of us have ever seen it,” said the London-based head of global government portfolios at Insight Investment, a$ 1 trillion asset manager. “So we must be humble and understand that your judgment may be wrong.”
A year after the pandemic drove the global economy into the deepest downturn in generations, bond investors are trying to figure out how the monetary stimulus and$ 20 trillion in global debt will trickle down to the financial system. Some, including bond bull HSBC Holdings Plc Steven Major, admitted to eating ‘humble pie ”after misjudging the market.
The key question is inflation and whether price increases will continue as economies reopen.
Federal Reserve officials have insisted that the rise in inflation rates would likely be temporary, even after the US consumer price hike in April by themost since 2009. Fed officials’ draft rates could be suspended until at least 2023. Traders are not convinced, with markets forecasting a tightening at the end of 2022 and a quarter point rise expected by March 2023.
“After the financial crisis, I certainly made the mistake of thinking that you might be able to ‘beat’ the forwards, so to speak, before the Fed hiking cycle, ”Lee said, referring to a judgment that bond yields would rise more aggressively than markets had suggested.
“It’s actually very difficult, and I think the same is potentially true this time around,” said Lee, who helps oversee $ 7 billion at Insight.
US benchmark yields fell to a record low of 0.31% last March at the start of the pandemic, and have rebounded to 1.77% this year, with traders betting the acceleration in inflation will remain .
Lee, who worked in bond sales in the 1990s at UBS Group AG, said yields on 10-year U.S. Treasuries are more likely to fall below 1% than normalize above 3% “at any time”. Indeed, the deflationary pressures that have plagued markets for decades – increasing automation, aging populations and declining global productivity – have not gone away.
“It will take years to be able to normalize beyond the 2-3% range” that we hope to enter now, said Lee, who has a doctorate in mathematics from the University of Oxford. “Almost all countries have a debt burden that companies or households would find it difficult to shoulder if yields increased by very modest amounts.”
His strategy? “Sit back and take an active position” if necessary, rather than risking losses. It abandoned most of its overweight positions in inflation-linked bonds.
Yields on inflation-linked five-year Treasuries, for example, fell to a record minus 2.005% this month as demand for protection surged. Some of these titles are “really fully evaluated at this point,” she said.
Lee is also underweight gilts on the growth outlook for the UK economy following an aggressive rollout of vaccinations.
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In the United States, Lee is watching the Fed’s language and economic data closely to determine its next moves. Weaker-than-expected US employment data for April supports his view that persistent inflation could be a pipe dream, while the Fed may postpone a discussion of cutback plans until the end of 2021.
“Unless inflation accelerates rapidly, it’s hard to see the circumstances under which you get rate hikes from the first half of 2023,” she said. “The era of low real returns and low returns may in fact reassert itself sooner or later.”