Week of October 31, 2022
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
I doubt any little kid dreams about growing up to be a central banker. But if you want the world to not only listen to every word you utter but dissect it in every boardroom, bar and blog, the profession should get added to the list. After all, how much attention does anyone really pay to rock lyrics?
This week, U.S. Federal Reserve chief Jerome Powell increased rates by 75 basis points. That was expected but the surprise came in the unscripted press conference. Markets entered the session thinking the Fed would share some comforting hints on pausing. Powell on the other hand made it clear it was “very premature to be thinking about a pause.” Those words immediately changed sentiment. U.S. equities had been up 1% but immediately turned and finished the day down 2.5%.
Powell emphasized there were three phases to the Fed’s tightening cycle: its pace, its peak and how long rates would need to stay high. Given how much tightening has happened already, he said the pace was less relevant going forward. He also noted the peak was higher than the Fed’s last estimate. And markets now expect it will be above 5% when the Fed shares its dot plot next month.
How long the fed funds rate remains high is more uncertain as it depends on the Fed wrestling inflation back to normal levels. Therefore, markets will remain all about the inflation watch and listening to, or second guessing, the Fed.
Source: U.S. Federal Reserve.
Steve Morris , Senior Managing Director, Liability Driven Investment
In its Fall Economic Statement 2022, released on November 3, the Government of Canada announced that it “has decided to cease issuance of real return bonds (RRBs) effective immediately.” The reason cited was low demand for RRBs. The next RRB auction was previously scheduled for December 1, 2022. The move was a surprise to bond dealers, and is unprecedented among G7 countries with an inflation-linked bond market.
Real return bond markets froze after the announcement. We expect that over the next few days institutional investors, investment managers and index providers will have discussions on a path forward for their existing products and allocations. We suspect that total return investors may no longer wish to hold on to their RRBs as the asset class becomes increasingly illiquid, and this could result in some supply in the short to medium term. However, investors that hold real return bonds to back inflation-linked liabilities, such as pension plans and insurance companies, will likely hold their existing positions to maturity and may look to absorb any supply as the market slows to satisfy any future planned RRB purchases.
Real return bonds have played an integral role in de-risking pension plans in Canada with benefits that contractually increase with inflation – either as an asset class directly purchased by those plans or purchased by insurance companies to back inflation-linked annuity purchases. This change may have an impact on any plans that wish to purchase indexed annuities or increase their RRB allocation.
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Plans with existing RRB allocations backing liabilities could consider holding these positions to maturity, as they should continue to provide a good hedge to their liabilities. To supplement their inflation hedge going forward, plans may look to use U.S. Treasury inflation-protected securities (TIPS), U.S. inflation swaps or real assets, depending on their objectives and risk tolerances. In the absence of a real return bond market, we suspect some plans will opt to purchase nominal bonds and attempt to offset unexpected increases in inflation through higher-yielding fixed income products such as corporate bonds or multi-asset credit strategies.
Source: Government of Canada.
Andrew Kleeman , Senior Managing Director, Head of Corporate Private Placements
In the corporate private placements group, we recently engaged in the following activities:
?What do these opportunities have in common? In all cases, we were the sole lender or an anchor lender in a structured transaction offering a specific solution to the issuer. Investors in our market that can analyze and structure complex credits and that have strong agent relationships are seeing more bespoke, limited distribution transactions. Sourcing these deals is an origination priority and enables us to present our clients with unique investment opportunities.
Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.
SLC-20221104-2576113