How is the fixed income investment environment changing? How prepared are investors?
Many investors are yet to realise that central banks have moved from a coordinated policy of quantitative easing to coordinated quantitative tightening. In part that’s because central banks had to be more vocal about their efforts to shore up markets during the crisis, whereas now they’re trying to normalise policy without triggering ructions. At the same time, policymakers know they can’t go it alone: they are only too aware of the distortions the European Central Bank caused when it set off on its own path and raised rates in 2011.
It started to become clear post the Sintra meeting in 2017 [the European Central Bank forum on central banking that was held in Portugal] that central banks were moving to a more co-ordinated tightening of policy. If you look at the Bank of Japan with its ‘stealth taper’ or the Bank of England with two rate rises since its post-Brexit emergency cut in 2016, in neither case is a tightening of policy justified by most measures of economic fundamentals. Labour markets might be tight across the globe but inflation remains relatively subdued with the traditional Phillips curve relationship between inflation and unemployment appearing to be much weaker than in the past.
Why, then, are central banks ignoring muted price pressures and continuing to tighten policy? At its core this round of policy normalisation is driven by two factors: first, central banks are worried about the political consequences of their past policies; and, second, they want room to ease when the world moves into its next downturn.
In combination, [central banks'] policies have indirectly fuelled populist politics around the world.
These factors make this round of policy tightening very different from that seen in previous cycles. Central bankers fear that in causing asset prices to become hugely inflated, they’ve caused the fabric of society to tear. Thanks to low wage growth and austerity, the middle classes have been stretched to breaking point, while an ever bigger proportion of wealth has become concentrated among what has become known as the “1 per cent”. This hasn’t been healthy for a world in which economic growth is based on credit creation and expansion.
Purchasing power has simultaneously shifted out of the hands of an economic segment with high marginal propensity to consume – traditionally seen as the economy’s engine – to one that has a much lower propensity to consume. As such, falling unemployment hasn’t set off the same inflationary impulse we’ve seen historically.
Zero interest rates have created another problem: what has, in effect, been a massive shift of pricing power from labour to capital. Ultra-easy monetary policy has made capital very cheap, or in some cases free, for corporations. This has discouraged investment in favour of financial engineering in the form of debt funded buyback and dividends. The net effect has been to create distortions that transfer value from bondholders to shareholders.
In combination, these policies have indirectly fuelled populist politics across the world. Central banks are consequently trying to normalise policy for a number of reasons that aren’t necessarily related to the build-up of inflationary pressures.
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