As the global macro environment continues an improving trend, its beneficial impact may be unevenly distributed. Franklin Templeton Fixed Income Views explores the implications for fixed income investors this quarter. One of the observations is that recent developments underscore investors need to be prepared to navigate significant bouts of volatility as markets reassess the likely timing and impact of monetary policy changes.
According to Sonal Desai, Chief Investment Officer and Portfolio Manager, Franklin Templeton:
“Supply-side-driven inflationary pressures remain center stage. Central bankers have insisted that inflation pressures are transitory, but disruptions to global supply chains persist, with component shortages and delivery delays pushing up prices; and, in the United States, the transition from unemployment to employment remains below historical trend, with several sectors showing high quit rates and robust wage increases.
“High inflation rates are beginning to filter through into inflation expectations: a recent New York Federal Reserve (Fed) Bank survey shows three-year ahead inflation expectations at 4%, and the University of Michigan consumer sentiment survey indicates consumers expect inflation to keep eroding their purchasing power.
“Persistent, it seems, is the new transitory.
“With household consumption and gross domestic product (GDP) growth proving resilient to the Delta COVID-19 variant, higher inflation has prodded the Fed to indicate it will most likely start tapering in November, assuming that economic progress continues broadly as expected. Tapering would proceed apace, with the Fed anticipating that asset purchases would come to an end by mid-2022; this would open the way for possible interest-rate adjustments. The Federal Open Market Committee, however, remains deeply divided on the timing of interest rate hikes, with half of its members anticipating a 2022 start and the other half looking at 2023. The median view implicit in the “dots” has become noticeably more hawkish in the last several months, as inflation pressures have proved more persistent than expected.
“Overall, the updated macro outlook confirms the main pillars of our investment strategy approach:
- With inflation risks tilted to the upside, we continue to favour shortening duration; we remain moderately bearish on both US Treasuries and eurozone government bonds, and neutral on Japanese government bonds.
- We maintain our moderately bullish view on emerging markets (EMs) government and corporate debt. While they have lagged in vaccinations and economic activity, we believe EMs stand to benefit from the synchronized recovery in developed markets and from the recent approval of an additional US$650 billion International Monetary Fund Special Drawing Rights allocation.
- US municipal bonds, both tax-exempt and taxable, continue to provide attractive investment opportunities, in our view, supported by both market technicals (including lower primary issuance) and fundamentals (a rapidly recovering economy and elevated stock market values underpinning local public finances). We have upgraded our view on euro high-yield corporates and continue to see selected value opportunities in US high-yield corporates.
- An active fixed income investment management approach remains essential, as sectors and individual companies will be affected in a very differentiated manner by a range of factors including the lifting of COVID restrictions, the influence of residual pandemic fears on consumer behavior, component shortages and other supply chain disruptions, policy and regulatory changes and technological innovation—as well as market technicals.
- Finally, recent developments underscore that investors need to be prepared to navigate significant bouts of volatility as markets reassess the likely timing and impact of monetary policy changes.”