What to Expect When Expecting Rates to Rise
2021 saw financial markets that were defined by transitioning expectations. Pivotal inflection points included the Bank of Canada’s mid-year hawkish turn and the US Fed’s year-end drop of “transitory” when describing inflation. In response, interest rate volatility increased and credit spreads widened, as markets prepared for the eventual transition to less accommodative policies from central bankers. The resiliency of the economic recovery is expected to be put to test.
North American policy rates have now come off their effective lower bounds, however, we do not have clarity on how high rates need to be and how quickly they need to get there to tame inflation without completely short-circuiting the recovery. We are in a shifting regime from rate hike anticipation to appraisal. Last year was about anticipating the timing and pace of policy moves, whereas this year is likely to be driven by evaluating the effectiveness and progress towards central bankers’ objectives given such moves. The path forward has many variables to consider leading to a wide-range of potential outcomes.
For the first part of 2022, financial markets have focused on decades-high inflation and its implications on central bank policy. However, intensifying geopolitical tensions have added another layer of complexity to an already fragile backdrop. The Russian invasion of Ukraine is emboldening both downside risks to global growth and upside risks to inflation. The immediate financial response to the conflict has been a flight-to-quality, with equity and corporate bond valuations weakening. However, bond yields have subsequently moved higher.
At this point, the channel of transmission to North American markets from the conflict is a deterioration in sentiment, tightening financial conditions and higher oil prices, however, more clarity on the severity and longevity is required to assess the full-extent of the impact. The rapid rise in commodity prices comes at a time when consumers are already facing rising inflation, acting as a tax on consumption, as well as higher input costs on businesses placing further pressure on profit margins. This may lead to a modest drag on growth. The evolving backdrop leaves central bankers in a precarious situation as they seek to contain the strongest price pressures in decades without derailing the post-pandemic recovery. Broadly speaking, the wide range of potential outcomes only further justifies our consensus expectations for volatility to remain elevated in 2022.
Ask the experts
Fiera Capital brings a diverse team of fixed income and private debt investment professionals as stewards of capital across multiple client segments. We have built a resilient, well-resourced, research-driven fixed income platform that has resulted in strong capabilities with varied sources of alpha-generation to develop client-focused solutions. Rates, curve, credit and liquidity are all sources of risk that provide our active managers with opportunities to exploit market dislocations.
We have asked our experts across fixed income, private credit and fixed income solutions teams to provide their insights and outlook on the market to investors amidst the uncertainty. We asked them the following questions:
- How has the current market volatility shaped your top-down market strategy?
- How are rising rates and declining growth expectations influencing the shape of the Canadian yield curve and are there sectors your strategy favours in this environment?
- As we consider the implications of the pandemic, inflation, geopolitical tensions and policy tightening, what do you believe will be the primary focus for financial markets over the next 12-months?
- Where are you finding value across corporate credit sectors?
- How has the pandemic and subsequent recovery affected investor demand for private credit?
- How has private debt origination been impacted by the pandemic and recovery?
- As inflation approaches record highs and central banks remove accommodative policies that have supported business, what are important characteristics the private credit team looks for in their portfolio of companies?
- How has the recent volatility in the market impacted the nature of the discussions on fixed income solutions that are being sought or discussed with clients?
- What advice would you give to investors as they construct fixed income solutions in the current environment?