Today’s gains could offset tomorrow’s pains
(Runtime: 5:00 Read the audio transcript.)
The normalization of financial markets in the near future will likely strip away some of the advances investments have made in the past couple of years, says Terry Moore, vice-president of T. Rowe Price Group.
Speaking on the Soundbites podcast, Moore said that as long as inflation stays high, central banks will have to intervene periodically to help reduce economic uncertainty, as they have done recently by hiking interest rates.
“So, yes, the party is over. Central banks are taking away the punch bowl. And there will be a few hangovers,” he said. “But the higher yields you receive today can help offset some of that future risk of interest rate increases.”
Moore said the reasons for central bank intervention are understandable.
“You’ve got high inflation, you’ve got the Russia-Ukraine war, China’s zero-Covid policy and, importantly — very importantly — central banks are going from easy policies to hawkish,” he said.
In addition, there are persistent labour shortages in key markets around the world. In the U.S., for example, job openings and quit rates are historically high.
“That means there just aren’t enough workers for the demand,” he said. “Immigration was cut back during the Trump years, and people are still suffering from long-Covid symptoms. Some of those folks remain out of the workforce.”
In January, the Brookings Institute estimated that long Covid is contributing to record high numbers of unfilled jobs and could account for 15% of the nation’s 10.6 million unfilled jobs.
Given the confluence of economic challenges, the actions of central banks around the world in 2020 and 2021 effectively pulled forward returns in those years.
“Now we have to give some of that back,” he said.
The 40-year bull market in bonds may be over, Moore said, but fixed-income investments continue to play a valuable diversifying role in a well-balanced portfolio.
“That diversification factor is very important,” he said. “When equity markets sell off in normal times, that allows the bond markets to help cushion the impact. That can provide one of two things. It can provide income for the investor who needs income for spending purposes. But it can also provide the ability for an investor to take some of those gains in fixed income and rotate to the equities that have declined in value if the investor’s thesis is that equities will eventually rebound.”
With short-term interest rates currently at 2% to 2.5% today, and longer-term rates at 3%, forward-looking returns are better than they’ve been in a long time.
He also stressed one of the basic tenets of bond investing. “Every day a bond accrues income for you, and that could help cushion any central volatility,” he said.
As for inflation, Moore said it may be peaking and should begin moving lower from here. Unfortunately, it’s likely to settle at a higher rate than what we’ve all become used to over the past decade.
“Inflation is a tax on consumers,” he said. “If you’re paying more for gas you’re going to have less to spend on other items. So as long as inflation stays high, [central banks] are going to have to remain vigilant and continue tightening policy.”
The bottom line
Even though the first quarter of this year was the worst quarter in the history of many fixed-income aggregated indexes, we are not in a 1970s-style inflation environment, Moore said.
“Central banks are still independent institutions who will hike until inflation is under control. Now, we can argue about supply-side and demand-side aspects of inflation and what central banks cannot control. But the reality is that the markets rely on credible institutions to help reduce uncertainty in finance companies and governments,” he said.
“And if you can invest in a flexible global fixed-income fund, then you can access the best-yielding opportunities from around the world while also being flexible enough to soften some of the speed bumps ahead.”
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.
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