With debt rocketing, GDP damaged, and business models threatened, RLAM’s Jonathan Platt tells us what is driving his outlook
Jonathan Platt, RLAM's Head of Fixed Income, says the course of the pandemic and the investment implications of alternative macroeconomic scenarios cannot be truly forecast - there are too many variables. But amid market distortions, could fixed income strategies still find the right balance of risk and return?
"This is a seismic change in the level of government debt, equivalent to wartime levels," he says, "with the flipside that the interest charge on governments is remarkably low." One key reason is that the clearing price is being artificially set by government agencies.
"We're heading for a situation where the Bank of England will own 50% of the state's stock of debt," he says. "The great unknown is at what point will investors say this has gone far enough - we're taking on debt we'll never be able to fund?" says Platt, with major knock-on effects on the ability of the state to support consumers and corporations. That day of reckoning seems to be a lot further away than people would have assumed a few years ago, he says, but remains unpredictable.
His best guess is that the medium-term government response will eventually combine, "an extension of quantitative easing on a global basis, higher levels of government debt, and tax rises targeted at income, but potentially also wealth, and the more resilient areas of the corporate economy." As the banks discovered in the 2007-9 global financial crisis, government support comes with strings attached.
He's not confident we will see a V-shaped recovery, though it's one of three central scenarios RLAM considers. "Damage has been done to the real economy and businesses will take time to adjust business models - a drawn out process with real pain when government support is reduced," he says.
For now, "we're in a kind of phoney war with the real economic impact only becoming clear over time," he says. "We also can't assume today's markets are anticipating a particular level or shape of recovery, because they're being significantly driven by liquidity and injections into the financial system," as well as the perceived resilience of the banking sector relative to the last crisis.
The distortions in the macroeconomic landscape mean different things for different parts of the fixed income market. Returns from investment grade bonds will be significantly determined by what happens to government bond yields, which he thinks, "will likely stay low but trend higher over time, with very low, possibly negative, returns for a couple of years."
Risk-averse investors may be happy to accept the return of capital rather than a return on capital, especially given present uncertainty. Very long-dated index-linked bonds have been performing well in the market, even though buying them can guarantee negative real returns over the lifetime of the bond, he says.
In this looking-glass world, duration may prove critical: "I think shorter duration strategies might turn out to give the best returns over and above cash - things like short duration investment grade bonds, short duration index-linked bonds, short duration high yield funds - simply because moves in the yield curve over the medium term mean that some longer-dated bonds will likely suffer," Platt says.
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