“The previous cycle was the longest in history and it ended only due to the exogenous shock of the pandemic”. This is one of the key takeaways from global multi-asset Neuberger Berman’s latest outlook paper titled ‘Solving for 2022’.
The events of 2020 and 2021 have naturally pushed the memories of 2019 further away, but for those seeking to understand the future, a closer look at the past remains important. It was the willingness of fiscal and monetary authorities to ‘support the cycle’ after the GFC, through what was seen as ‘unconventional policy’ that ultimately drove the long economic expansion, according to CIO of Fixed Income, Brad Tank.
Expanding on today’s market, he says “we are moving from recovery phase of the current cycle to its middle phase” with central banks willingness showing no signs of slowing. Tank expects this to be the beginning of another long cycle, but one which encounters more volatility than we are used to due to ‘inflation and new redundancies built into supply chains’.
Whilst all the focus is currently on whether the short-term and determining the transitory nature of current inflation, there is little doubt that inflation will be ‘higher and more problematic’ according to Neuberger. “After 40 years of declining inflation and rates, the direction of travel appears to be changing” citing a change in direction by China, the energy transition, supply chains and labours growing power as key influences.
“Supply-side or cost-push inflation” is unfamiliar to most of us, but particularly central banks with this unique dynamic set to pose a significant challenge to central banks which have historically been focused on influence demand and the supply of credit. For this reason, a key driver of market direction will be “how central banks choose to navigate a changing inflation environment in the coming year”.
Despite the outlook for greater volatility and the end of a four decade bull market in bonds, Tank believes the result will be “an orderly adjustment for bond yields and spreads”. He believes that credit spreads are ‘priced to perfection’ and that the direction of travel will be up and wider, but that “major market disruption or significant credit issues appear unlikely”. In this vein, a more tactical fixed income environment is developing, offering opportunity for active and diversified strategies.
Focusing specifically on fixed income markets, which stand to be impacted most by the change in direction of bond rates, Neuberger is suggesting investors “pursue a more flexible approach to seeking income” in 2022 and beyond. The combination of low and rising rates along with tight credit spreads, means investors are likely to “double down” on their search for short duration, floating rate and less correlated sources of income.
“They may complement this with more tactical positioning, whether that be in interest rate risk exposure, asset allocation or into narrower, niche, but attractive markets”.
He says the “opportunities likely to draw attention range from short duration credit, loans and collateralized loan obligations (CLOs) to China bonds and European corporate hybrid securities.”
In conclusion, Neuberger suggest a flexible allocation of diversified fixed income sectors including these short-duration, less-correlated and tactical sources of income could pay dividends in the year ahead.
Click here to read more about Neuberger Berman’s annual market outlook – Solving for 2022.
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