Most parts of the fixed interest universe are generally seen as defensive and an alternative to higher risk equity assets. So, what are the biggest risks hanging over fixed interest today? We had a chance to ask an expert when Stuart Dear, Deputy Head of Fixed Income at Schroders Australia sat down for an interview with Livewire recently.
He touched on the unlikely risk of inflation, as well as a liquidity event such as a major institution collapsing, before citing the risk of central banks changing their regimes. Stuart told us, “if they changed the tools that they use, including maybe coordinating with fiscal policy in a more material way, the game probably changes”. Watch this video for his full views, including why he thinks the odds are high that QE will happen in Australia.
“The first and greatest risk always I guess is inflation. There's possibly some upside inflation risk in the near term through oil prices, with tensions in the Middle East, possibility of some sort of conflict between the US and Iran, for example. If we were to see that, we'd see that more as a shock to growth, a downward shock to growth, rather than really a more meaningful upwards risk to inflation. We don't really see that as the driver.
In terms of a longer-term inflation risk, I think the macro environment is such that those longer-term inflation risks which at high debt levels, have to be considered. I think they're too far in the future to really worry about just for now.
We talked about liquidity risk in credit. Probably we need to see an event of some sort to materialise liquidity risk, so we need to see a bank blow up or a big hedge fund manager get into trouble. It's always hard to know in advance whether you're going to get these things. They're hard to identify. We don't think there's the same degree of leverage in the system as there was prior to the GFC, so it's not as obvious that we're going to have an event, but there are a few things bubbling around that urge you to be a bit cautious.
And then finally, and I think this is really a longer-term risk, the possibility that central banks change their regimes. They've been focused on targeting a very narrow measure of inflation, consumer price inflation, and they've had fairly limited tools at their disposal. If they were to change their policy framework, if they were to say, "We're going to target a much broader measure of price inflation, including assets," policy probably wouldn't be as accommodative.
Or if they changed the tools that they use, including maybe coordinating with fiscal policy in a more material way, the game probably changes a bit.
But right at the moment, central banks are actually doubling down. They've tried all these stimulatory measures over the last decade which haven't really had a lot of success in terms of real economy outcomes. But, in spite of that, they're trying even harder at the moment.
There's a whole round of easing going through, including by the RBA. We're not in unconventional territory yet, but we're actually not too far away. Central banks I guess are sticking to their guns, but there's a risk at some point that they could change their approach and that would be destabilising for fixed income markets for sure.
The chance of QE being implemented domestically is pretty high. The RBA has made it clear they don't want to take rates negative. I think they've learned from the experience of elsewhere that creates problems for banks, in particular, and a whole heap of disincentive issues. But obviously they've done the groundwork in terms of how to apply QE. They've, again, learned from experience elsewhere. Australian market's a bit different, they'd apply it a bit differently.
We think the cash rate is going lower in the near term. It probably goes to half a percent, thereabouts, over the next little while. Next step, assuming they stick with their inflation targeting mandate, and they're not able to generate inflation, next step would be QE in some form.
Probably it'll look different to what's happened elsewhere and doesn't involve a whole lot of long-term government bond buying. Most likely it's focused in the short end of the curve, providing liquidity essentially, to be able to allow banks to price more effectively.”
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