Hello, I'm R.J. Gallo, Senior Fixed Income Portfolio Manager at Federated Hermes.
What's driving inflation risks in developed markets?
Recently, inflation expectations which you can see in the marketplace from break evens on Treasury Inflation-Protected Securities or TIPS, have been heading higher. Fortunately we've been well positioned for that within our multi-sector portfolios here at Federated. We've been overweight. The increase in inflation expectations is linked to a variety of factors. First and foremost, a vaccine is on the way. Vaccination worldwide is a precondition to a return to normalcy. Vaccination, return to normalcy, economies expand, and with that we would expect prices and the price level here in the United States and in other developed markets to be heading higher. At the same time, recall that central banks worldwide have basically collapsed their interest rates to record lows, sometimes negative in Europe, around zero here in the United States. So high levels of monetary accommodation, very stimulative monetary policy, fiscal policy that's apt to expand a new administration, and vaccination that is going to support a normalization of economic activity, prices should be on the way up. The important thing is, How high do they go? And there's a certain level of uncertainty let's face it. For decades now developed countries have under inflated, we've experienced levels of inflation that have just been lower than central banks were targeting. That's true here in the United States as well as in other developed countries around the world. Will this time be different? The demographics suggest don't worry so much that inflation is going to spike. That said, uncertainty is a little elevated, and as a bond manager and as a bond investor, inflation is your enemy. So we have to position somewhat cautiously with respect to the risk that inflation is on the way up. Our base case, it should be manageable in the near term, and the Fed wants it to get to 2% higher before they tighten rates, that should be somewhat calming to fixed income investors in the year ahead although returns are apt to be pretty modest in high quality fixed income in 2021.
Disclosure: Views are as of Jan. 14, 2021 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. Federated Investment Management Company 21-40019 (1/21)