The Fed has learned its lessons from the past decade and won’t push too hard too fast with uncertain economic conditions still constraining business, says Jacob Vijverberg, Investment Manager, Multi-Asset Investing at Aegon Asset Management.
With the economic recovery well underway, Vijverberg says the debate is ‘raging’ around inflation and other factors that influence monetary policy makers’ decisions. But he believes that major economies are some way off rate rises, and that the Federal Reserve (Fed) has largely learned its lesson after 2013’s taper tantrum.
“The Fed and investors have likely learned from the ‘Taper Tantrum’ experience in 2013, when rates moved higher on the announcement that tapering would start” he says. “Currently changes are well communicated in advance. The Fed will raise its main policy rate after QE has been wound down, starting in 2023. We expect the pace of rate hikes to be slow, with rates rising only to around 1% in 2025.
“Due to the sharp rebound from the pandemic, the economy will be operating at full capacity from 2022. We therefore expect that this economic cycle is relatively short, which rate markets will price in. Also, the sharp rise in debt levels and low rates in other parts of the world will exert downward pressure on US yields.”
Vijverberg says current economic conditions provide much uncertainty for rate setters, but key indicators such as unemployment reports will be the indicators the Fed is watching.
“Despite a strong recovery from the pandemic and a higher inflation rate, most sovereign rates are still below their pre-pandemic levels” he says. “This is due to unprecedented monetary support in the past year. Central banks have lowered rates and implemented very large asset purchase programmes to soften the economic impact.
“A key element influencing the subsequent rate of the normalisation is the reduction in government support programmes. Now, as the pandemic stimulus wears off, the strength (or lack thereof) of the recovery will be determined by how firmly private enterprise takes the reigns.
“Another important area to watch for normalisation is the labour market. During the pandemic labour participation fell. In the coming years, the degree to which this slides back to historic levels will illustrate the magnitude of normalisation.”
Finally, Vijverberg says the ‘raging’ inflation debate is overblown with transitory price rises still the most likely outcome. With that, he says rates should stay low across the board for the foreseeable future.
“We fall on the transitory side of the raging inflation debate. We don’t believe the structural factors are there to drive sharp sustained price increases for multiple years. Rather, many of the current price pressures are associated with items that are directly tied to supply-chain bottlenecks caused by mass re-opening of the economy. Furthermore, we believe long-term inflation expectations will continue to be anchored, a key determinate of Federal Reserve policy.
“Interest rates should rise marginally compared to the current implied rates. This in general leads to a low return expectation on sovereign bonds. Within sovereign markets, the Gilt markets stands out as its rates have more scope to rise.
“Interest rates are expected to remain low, partly due to central bank policy. Inflation adjusted, interest rates are even negative in most regions. Assets which are linked to nominal growth, like equities and real estate should benefit as negative real rates are accretive for equity holdings. Equities and real estate are attractive asset classes, also from a risk-adjusted perspective.”