Private jets fly delegates into Glasgow to cut emissions and make climate plans – let’s hope there’s some walk to accompany the talk.
This week saw Jay Powell confirm that the Federal Reserve (Fed) will begin tapering its QE purchases of Treasuries and mortgages from this month. This was widely expected, having been effectively pre-announced at the September FOMC meeting.
It is anticipated that the taper process will run its course by June. With the economic backdrop remaining relatively robust, money markets largely price two hikes from the Fed in the second half of 2022.
This trajectory for rates next year is largely in line with our own thinking. However, we are inclined for growth to remain robust and for inflation to remain more persistent than the consensus, such that we believe too little is priced with respect to the future trajectory of Fed Funds thereafter.
Consequently, following a period of pronounced curve flattening, we look for some re-steepening of the yield curve, with longer-dated yields lifting after being broadly rangebound over the past month. In particular, we would observe an asymmetric profile for rates, with a skew towards higher yields between now and the end of 2021 – we see robust data driving this price action.
In the eurozone, by contrast, we believe that the extent of the sell-off in money market rates over the past month has been over-done. Although hawks in the ECB have become more concerned with respect to the inflation trajectory, the eurozone economy still operates a material output gap and accommodative monetary conditions remain warranted.
Consequently, we believe that there will be an extension in asset purchases within the APP to coincide with the expiry of the PEPP programme in March. We expect this to be announced at the December ECB and that central bank purchases should absorb most of the net eurozone sovereign issuance during 2022.
This should continue to support eurozone yields and spreads in coming months, though the risk of a more hawkish outcome could be a source of some pressure.
Over the past month, Italian BTP spreads have widened on fears that asset purchases may dry up more rapidly – we recently added exposure in the wake of this. We would note that the fiscal performance in Italy has been relatively disciplined and arguably Spain is more culpable of fiscal largesse. Should spreads widen in 2022, we would not be surprised to see Bono yields top Italian BTPs, but in the short term, we feel that the outlook into year-end should be well supported.
Meanwhile, the Bank of England (BoE) delivered a dovish surprise this week, keeping rates and asset purchases unchanged. With inflation pressure building, recent BoE comments had appeared to highlight that action was imminent.
However, the MPC decided to hold steady for now – even if it was a close call. This saw UK yields rally abruptly and sterling come under pressure in the wake of the monetary policy meeting. We continue to think the BoE is too sanguine on inflation and how persistent it will be heading into 2022.
We think UK CPI can rise materially above 6% next April, as we don’t see supply bottlenecks and labour shortages in key sectors resolving anytime soon. In that respect, we expect 10yr Gilt yields to rise over the medium term as bonds are shunned.
At the same time, government policies, including a confrontational Brexit stance and a squeeze in living costs, compound the prospects of stagflation in 2022, making UK assets, including sterling, an unattractive investment going forward.
Notwithstanding recent volatility in global rates markets, credit volatility remains very subdued (at least away from pockets of distress, such as China real estate).
Risk appetite has been buoyed by equity markets posting new highs in the wake of robust corporate earnings, stable long-term discount rates and solid retail participation. An example of the latter factor was movement in the stock price for car rental firm, Avis, which doubled in value on Tuesday after attracting meme interest on chat boards.
In credit markets, spreads remain broadly rangebound for now. Currency volatility also remains subdued, with the dollar trading somewhat firmer in the wake of this week’s FOMC but without much impetus or conviction.
We are hopeful that US payroll data today should be relatively firm. After a couple of weak prints in the wake of softness induced by the spread of the Delta variant, we think that jobs growth can rebound into the end of the year, buoyed by labour market demand. We believe that solid data now holds the key to higher yields.
For the foreseeable future, we see the Fed as on auto-pilot, although if unemployment can fall then yields could well rise – especially with inflation prints set to take another leg higher. Meanwhile in the UK, we see the rally in Gilts following the MPC meeting as likely to be short-lived, as the focus returns to inflation and questions start to surface, insinuating that the BoE may be subject to political pressure to hold rates down.
Meanwhile, this week’s global focus was further north in the UK with the COP26 summit held in Glasgow. Global emissions have risen notably after dipping during lockdown last year, and the need to tackle the factors driving climate change has never seemed more imperative. However, one wonders whether commitments will be sufficiently binding and it is always frustrating to observe an abundance of talk over action.
Moves to limit coal and plans to stop deforestation are laudable, but the impressions of a ‘good COP’ seem to sit ill at ease with the ‘bad COP’ pictures showing the rows of parked private jets used to fly delegates in and out of the summit. Maybe a ‘zoom COP’ would have had a better carbon footprint.