The “snail-like” pace of central bank policy normalisation will eventually lead to a “benign unwinding”, but risk assets could still experience headwinds, says Natixis Global Asset Management.
“After nine years of extraordinarily easy money, central bankers are finally beginning the ‘normalisation’ process – raising rates and shrinking balance sheets,” said Natixis chief market strategist David Lafferty.
The US Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan are “all at different points in their journey to normalisation” in the backdrop of “strong growth, falling unemployment, improved resource utilisation and the expectation that these conditions will create inflation pressures”, factors that are leading central banks to consider pulling back stimulus.
“The change may be imperceptible at first, but make no mistake, the tide is beginning to ebb,” Mr Lafferty said.
Regarding portfolio implications for fund managers, Mr Lafferty said, “We expect bond yields to remain range-bound with a small upward bias as real and nominal growth rates still exceed real and nominal interest rates.
“Constraints on potential growth (weak labour/population growth and low productivity) coupled with the global savings glut (the nearly insatiable demand for fixed income from an older population) are likely to limit the rise of global bond yields further out the curve.”
Meanwhile, “organic demand” would be expected to make up for “any slack created by [quantitative tightening]”.
“We still like the corporate and structured sectors of the bond market, but current spread levels don’t warrant taking on excessive credit risk,” Mr Lafferty said.
“We prefer BBB [rated loans] and bank loans to high yield, and [asset-backed securities] and [commercial mortgage-backed securities] to agency [mortgage-backed securities],” he said.
“Regardless of sector allocation, low starting yields, modest upward pressure on interest rates (price headwind) and tight credit spreads will result in below-average returns across the fixed income complex.”
Earnings growth would stay positive, but price multiples would not increase much further than existing levels, the note said.
And while risks were “unlikely to occur (less than 50 per cent chance)”, there were still some to consider, in that no one could guarantee a crisis would not occur.
“Tthere is no historical precedent for letting the air out of a balloon this big,” Mr Lafferty wrote.
Additionally, the outlook was based on the assumption that the global economy maintains its trajectory of growth, and that inflation was “muted”.
“If inflation does peek out of its hole, central banks will pull back harder, yields will rise more dramatically and [price-earnings ratio] will fall,” he wrote.
“To summarise: the best case result is positive but lackluster returns. The worst case is asset bubbles popping.
“Note that in either scenario the balloon gets smaller – it’s just a question of timing and impact.”
Natixis took a majority stake in Australian equities manager Investors Mutual Limited on Tuesday.
