Macroeconomics

As 2021 wore on we became increasingly concerned that the disconnect between asset prices, economic fundamentals and monetary policy was becoming more acute.

For fixed income investors, the start to 2022 has been trickier than any we have experienced for many years, but we think this difficulty is to be expected and aligns with our macro view.

Powell’s hard line may have surprised investors, particularly in light of recent market volatility and increasing geopolitical risk in Eastern Europe, but the Fed’s fear of prolonged higher inflation looks to be trumping those concerns.

If 2021 was a bad year for global bond returns, it follows there were few natural shelters to be found within fixed income from the brunt of inflation and rates-driven volatility; the Barclays Global Aggregate Index (a widely used broad measure of bond performance) returned -4.7% in USD terms, while European investment grade credit returned -1.1% despite credit spreads tightening over the course of the year.

It has been a very interesting start to the year in the rates sector of the market.

Given the swiftness of the Fed’s pivot we think risks are tilted towards the central bank doing more and not less. We wouldn’t even rule out a 50bp rate hike at some point.

Jerome Powell’s recent testimony to the Senate Banking Committee, in which he said the Fed would discuss a faster taper of its asset purchases at December’s FOMC meeting, has led to intense speculation that we could see a move this week.

Against a backdrop of 4.20% year-on-year UK consumer price inflation (CPI), if you got your timing right, linkers (inflation-linked UK government bonds) will certainly have outperformed conventional Gilts by some margin.

What we are currently experiencing is a disconnect between monetary policy, the economy and the markets, a disconnect that in our view will struggle to survive much longer.

This week the team at TwentyFour have been busy compiling our 2022 fixed income outlook, which will be published next week. There is no doubt we are confronted with a challenging set of circumstances, which will provide investors – not just in fixed income – with headwinds in the year ahead, and in particular we think during the first half.

Before the pandemic struck in February 2020, there were 159 million employed Americans; by the end of April that year, 26 million jobs disappeared. Since then, politicians and central bankers have focused on recovering all jobs lost to the pandemic fallout and returning to pre-COVID levels.

So that’s the banks, rates, swaps and currency traders that all apparently got the wrong end of the stick. Explaining how you might arrive at a future monetary policy decision is a challenging and fine balancing act, but as Governor of the Bank of England that is of course one your jobs.