- We're seeing some wage pressures and some elements of a labor shortage, definitely in the U.S. and potentially globally. Keep an eye out.
- The market’s reaction to Fed remarks may be exaggerated, but negative real yields continue to be a dominant force. One of the reasons why Bond Connect is so interesting and so important is that China represents a vast market with positive real yields—hard to find elsewhere.
- The consumer balance sheet, in aggregate, is strong relative to both historical metrics as well as versus the health of corporate and government balance sheets. The ability for consumers to service and pay down debt provides a strong fundamental tailwind for securitized bonds, particularly consumer-backed ABS and residential mortgage securities.
Recently, the Fed spoke about how the U.S. economy was developing better than they had expected. They saw both growth and inflation as higher than they previously forecasted. This prompted the board of governors to move their timing of hikes forward by a few months, although still a couple of years from now. This was a punch in the market’s gut.
The timing estimate alteration was more due to positioning differences, really than a huge change in communication from the Fed. I would say that the Fed unanimously adopted a new inflation targeting framework last year, and part of that inflation targeting framework was that they would wait much longer to act than they had previously. It would be very unusual if the Fed were to change that framework again so quickly, and more likely the statement was simply the acknowledgement of the fact that growth and inflation were maybe notably higher, but still not likely to change their trajectory much.
However, inflation expectations are picking up. There are a lot of questions around the effects of inflation, both in the United States and globally. Although it's difficult to figure out how temporary supply/demand balances might pass through to long-term price pressures, what investors really need to be looking at are the changes to levels of global wages. Wages are much stickier than goods prices. Lumber costs can go up and down, and commodity costs generally can go up and down, but once you get an increase, it’s hard to unring that bell. As somebody once said to me, “A raise is a raise for about three months, then it's just your salary.” It almost never goes the other way. We're seeing some wage pressures and some elements of a labor shortage, definitely in the U.S. and potentially globally. Keep an eye out.
Real Yields are Negative, but Consumer Balance Sheets are Strong
Real yields across the world in developed markets are essentially negative. This is an unprecedented condition and something which is extremely stimulative to the global economy, but the removal of that stimulus and the removal of that combination are challenging as we have seen recently. The market’s reaction to Fed remarks may be exaggerated, but negative real yields continue to be a dominant force. One of the reasons why Bond Connect is so interesting and so important is that China represents a vast market with positive real yields—hard to find elsewhere.
Global households in many places around the world are in much better shape than governments or companies. The consumer balance sheet, in aggregate, is strong relative to both historical metrics as well as versus the health of corporate and government balance sheets. The ability for consumers to service and pay down debt provides a strong fundamental tailwind for securitized bonds, particularly consumer-backed ABS and residential mortgage securities. Securitized bond investing allows investors to access sectors and securities with different risk/reward characteristics, underlying loan diversification, and loss protection features.
Increased Market Size Does Not Equal Greater Liquidity
I would caution investors who believe that lots of supply and larger market size equals good liquidity. Unrestrained issuance doesn’t necessarily lead to better investment opportunities.
In fact, liquidity tends to increase in good times, and evaporate in very bad times, and this exacerbates the market cycles that we’re seeing. When markets have a thirst for liquidity, it’s nowhere to be found, and that’s the environment we’re in, and a direct result of how markets have evolved due to regulation and to investor preference.
Liquidity is particularly important, given flows can be dramatic. One of the reasons why we saw the fastest downturn in credit markets in history in March 2020, was that flows in the worst week were 18 times worse in 2020 than the worst week in 2008. So, more money into markets, more money in and out of markets means that liquidity management is more and more important. That provides an opportunity. If you have got cash when other people don’t, you get some great prices, and ultimately that’s how we’re structured to manage and that’s what we executed in 2020.
Summary: Risk Up, Reward Potential Down
Generally, however, the compensation for taking on risks of over and above high-quality fixed income is pretty low. Heavy issuance by both corporates and the government at low rates has created a lot of unattractive paper. Therefore, we're risk adverse, but the risk we are taking is more in global consumer balance sheets versus corporate or Treasury balance sheets.
And lastly, across the world you've seen a significant increase in duration and interest rate risk with a significant decrease in yield: The global aggregate index is at a duration of 7.4 years and a yield of 1.1. In 2010, the global aggregate had a duration of 5 years, so less interest rate risk, and a yield of 3.1, so almost three times as much yield. In 2000, back when everybody was buying internet stocks, just like they are today, the global aggregate had a duration of 5, so the same as 2010, but its yield was 5.8, which was a significant real yield, significant over and above inflation.
All this is to say risks are relatively high in fixed income and rewards are relatively low. Fixed income is really being used as a policy tool globally, and that's just something that we as investors both in global fixed income and in global equities are required to navigate, and it's producing some very unusual markets.
Jason Brady, CFA, is President and CEO at Thornburg Investment Management.
The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.
This is not a solicitation or offer for any product or service. Nor is it a complete analysis of every material fact concerning any market, industry, or investment. Data has been obtained from sources considered reliable, but Thornburg makes no representations as to the completeness or accuracy of such information and has no obligation to provide updates or changes. Thornburg does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein.
Investments carry risks, including possible loss of principal.
Outside the United States
This is directed to INVESTMENT PROFESSIONALS AND INSTITUTIONAL INVESTORS ONLY and is not intended for use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to the laws or regulations applicable to their place of citizenship, domicile or residence.
Thornburg is regulated by the U.S. Securities and Exchange Commission under U.S. laws which may differ materially from laws in other jurisdictions. Any entity or person forwarding this to other parties takes full responsibility for ensuring compliance with applicable securities laws in connection with its distribution.
Please see our glossary for a definition of terms.
Founded in 1982, Thornburg Investment Management is a privately-owned global investment firm that offers a range of multi-strategy solutions for institutions and financial advisors around the world. A recognized leader in fixed income, equity, and alternatives investing, the firm oversees US$45 billion ($43.3 billion in assets under management and $1.8 billion in assets under advisement) as of 31 December 2020 across mutual funds, institutional accounts, separate accounts for high-net-worth investors, and UCITS funds for non-U.S. investors. Thornburg is headquartered in Santa Fe, New Mexico, USA, with additional offices in London, Hong Kong and Shanghai.
For more information, please visit www.thornburg.com