Transcription of Finance News Network panel discussion with Antares Fixed Income Fund Investment Manager – recorded on 18 August 2016, with Ken Hyman and Portfolio Managers, Tano Pelosi and Mark Kiely.Ken Hyman: So guys, markets have had an uninterrupted rally since late April. This will be a two-day gap after Brexit, and then it continued with a vengeance. Equities, bonds, credits, property (anything that’s got a yield) – I see it a bit like a tsunami where the eruption takes place at far away countries or lands – such as Europe and Japan. And then that wave of demand just branches out and is washing over our land big time at the moment. So is pricing getting ahead of itself, Tano?
Tano Pelosi: Well if you think about pricing in terms of the terminal cash rates for the Fed, BOE, ECB, what you’re seeing is a uniform collapse in terminal rates. So the path for interest rates is very shallow and the outlook for interest rates, official cash rates, is going to be much lower than it has been in the past. In particular, if you look at the post-Volcker period, through the 1980s onwards, typically a rate cycle looks like 200 to 400 basis points over 1-2 years. So this cycle is very different in that respect – lower and much longer than what we have seen in the past. But I would say, at the same time, there are some fundamental reasons for this and it is particularly the structural aspects to what’s going on. The banks have been viewing this very much with a cyclical mindset, yet many of the problems are structural in nature. And the central banks are now coming to the realisation they are really pushing on a string.
Ken Hyman: So Mark, do you think this demand is sustainable?
Mark Kiely: I think as Tano said, there are structural problems there. But there are also massive amounts of central bank intervention. And that is driving huge amounts of flow into risky assets and the search for yield is strong so I think it can go on for some period of time forward.
Ken Hyman: And what can go wrong?
Mark Kiely: I guess if you look at what may go wrong, what we’ve seen go wrong in the past (looking back at the last 5-6 years) – if we look at the episode we’ve seen, tantrums in rate structures such as 2010, not long after QE was announced in the US. We saw rates rise 130-140 basis points. That caused ricocheting into risky assets, equities, etc. We then saw the famous taper tantrum in 2013, when Bernanke announced they would ease back on their QE program. That caused a fair bit of volatility in risky assets as well during that period. And rates also rose around 130-140 basis points in the US.
More recently, early 2015, we had a mini-tantrum in yields, which rose 80-85 basis points in the US on the back of expectations that the US cycle was coming to an end, and rate rises would be coming, and we had big amounts of QE purchases. So I think we now look into a period where there has been a bit of Fed speak about maybe raising rates again. The question is whether they can afford to do so. But if they do it this time, the big question is there is so much QE awash in the world outside the US (particularly coming from Europe and Japan, and outside the negative rate cycle countries).
Even if the US starts to raise rates here, I think the effect on the rate market and, therefore, the effect on the equity and other risky assets are going to be much lower. And the point that Tano makes, expectations of terminal cash rates are also much lower now than what they were in those previous cycles. I think that also puts a cap on potential rate rises and volatility.
Ken Hyman: The way I look at it, you don’t fight against central banks. They have very deep pockets, and in a taper tantrum, what I recall, the markets were very surprised and there was nobody standing against the selling. So it was an aggressive sell-off for a lengthy period. But even after Brexit, the demand seemed to come in pretty quickly, notwithstanding the elevated risks that the market hadn’t been pricing at all. So Tano, just on that, what could go wrong? Mark has referred to the Fed. Any other assets ...
Tano Pelosi: There are 2-3 things that are obvious candidates for a backup in yields. One is an inflation scare – hard to see a sustainable pickup in inflation over the near term, certainly from my perspective.
The other one is that we see what I call a ‘fiscal re-flation’ – governments get their act together, we get better governance across the advanced economies, and we get a lot more fiscal spend. Smart growth-orientated fiscal spend, so that could also do the trick. But I would also make the key point here that whilst the markets are not really discriminating in terms of the trajectory of Fed funds or official rates going forward, certain economies are further along the path of recovery than others. And that’s one thing markets need to grapple with, going forward – how that tangles.
Ken Hyman: Just on that point you raised, on shifting from monetary policy to fiscal, I see a structural shift happening. If you look at both parties in the US election – they are out-campaigning each other on how aggressive they will be on spending and how wide they are going to blow out the budget deficit. Contrast that with the last election, when both parties were talking about how they would get the budget back into surplus. So you need a leader if you’re going to move towards more fiscal spending. It’s not politically popular but it it’s very much on the table in the US. And yet you contrast that with Australia, it was very much off the table. In our election, AAA was first and foremost.
Tano Pelosi: Fiscal spending, coupled with reform. If we’re talking about the Euro area, there needs to be reforms around labour markets, microeconomic reform, and there’s also issues around the debt loads some of these economies are maintaining. So that needs to be addressed as well.
Ken Hyman: So, we’ve highlighted a couple of risks that are out there. The markets at the moment – some would say complacent, others would say they are reading the situation as: it’s driven by central banks, they’re on a mission, and don’t stand in front of it. But we had the Fed minutes out last night (Australian time), and I thought, bearing in mind, there have been two labour market monthly reports that have come out subsequent to that meeting, it was definitely – I wouldn’t even say it was split down the middle. I would say holding rates was definitely the majority. But do you think with two stronger labour figures and some decent data as well that Janet Yellen at Jackson Hole next Thursday could raise the ante?
Mark Kiely: That’s definitely a possibility that they might want to put back on the table – that rate rises are definitely on the agenda at some stage. The market, as we know, has unwound a lot of expectations and is currently only factoring in 50% probability of a rate rise by the year end, which is very low. And the Fed would probably like to see the markets factoring in a bit more than that. So I wouldn’t be surprised if Yellen comes out and makes comments which suggest that rate rises are on the agenda. She probably won’t be specific on timing, but just wants the market to be a little bit more aware and to not be so complacent with regards to expectations going forward.
Ken Hyman: Would you agree with that?
Tano Pelosi: To a large extent, I do. I think there is a strong willingness within the Fed to push rates higher. But at the same time, there are afforded a fair bit of scope in terms of holding back, letting see the whites of the eyes of inflation come through and then react. So there is a certain asymmetry around the policy with respect to inflation, which I think the risks are certainly skewed to the other way. If they hike, we could see a repeat of what we got in January-February this year.
Ken Hyman: That’s something I wouldn’t say that I look forward to – but to position for. Guys, thanks a lot for the chat, and look to catch up maybe after the next Fed meeting.
Ends
