Tracking the path of the policy response
What central banks lacked in policy rate room as they entered the Covid-19 crisis, they made up for in the speed and scale of their response. Every G10 central bank delivered at least one off-schedule policy announcement in March. Within two weeks, the Fed delivered more easing than it did over two years during the Global Financial Crisis.
Quantitative easing has resumed in the US, UK and Sweden, expanded in Europe and Japan, and commenced for the first time in Australia, Canada and New Zealand. Australia has innovated further and adopted yield curve control. Measures undertaken seek to ease financial conditions and support market functioning. Monetary actions have been accompanied by sizeable fiscal packages comprised of loans to businesses on attractive terms, employee-pay guarantees and direct transfers to households and small businesses.
Central bank support for credit markets may help them outperform equities
The global policy response is unprecedented but varies by country and the unique nature of the current economic shock—a pandemic that requires extensive mitigation measures—creates a higher than usual degree of uncertainty with respect to the path for both growth and inflation. In the near-term, we think the disinflationary impact of weaker demand and lower oil prices will outweigh the reflationary consequences of supply-side disruptions.
The interaction of accommodative monetary policy and large-scale fiscal expansions will create investment implications for interest rate and currency markets. The pandemic may, over time, progress us into a higher inflation regime. As noted, the fiscal response has been substantial and in the coming years, this may create an incentive for governments to tolerate higher inflation in an attempt to reduce the real value of higher public debt. At the same time, central banks may be wary about normalizing policy if the recovery is perceived to be fragile.
Policymakers may also grow more tolerant of above-target inflation, following a prolonged period of below-target inflation. There is also potential for term premium—which has been on a secular downward trend—to rise due to public debt amassed by governments. As a result, we may encounter higher bond yields and steeper yield curves. But moving into this higher inflation and yield environment is a process and not an event; it will take time to transpire.
Our investment strategy is currently focused on opportunities arising from security selection and market dislocations, as well as beneficiaries of global policy. For example, mortgage-backed security (MBS) spreads remain wide relative to their history but stand to benefit from US Federal Reserve buying. We also see value in US investment-grade corporate credit. More specifically, short to intermediate maturity bonds offer an attractive risk-return profile for opportunistic investors, while longer-term credit can offer an alternative to low-yielding government bonds for pension plans and other long-term investors.
Hugh Briscoe is a global fixed income portfolio manager at Goldman Sachs Asset Management
Bull points
Fixed income assets, including corporate bonds and MBS, in the path of the policy response are supported by unprecedented stimulus.
US investment-grade corporate credit spreads offer significant compensation for recession and downgrade risks. The asset class also benefits from policy support and demand for yield and diversification against equity risk.
Bear points
The economic outlook is characterised by an elevated degree of uncertainty.
Policy ammunition may be limited in event of a further economic shock.
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