The war in Ukraine is unlikely to derail in-train inflation and interest rate trends, global fund managers MFS and T Rowe Price told investors last week.
In a note to clients, Robert Almeida, MFS global investment strategist, says the Russia-led war will only add inflationary fuel to the fire as rising oil and commodities prices spill over to “global growth and corporate profits”.
“And given the high starting point for inflation (7.5% in the US and over 5% in eurozone), I fear economic models may understate the impact of a further rise on overall inflation,” Almeida says.
He says the war, and consequent financial and economic reactions, increase the odds of stagflation, leaving central banks in a difficult position and exposing any corporate “financial fragility”.
Faced with such shocks, “companies that are least dependent on things outside their control, such as external financing, tend to outperform”, Almeida says.
Furthermore, he says the buy-the-dip mentality supported by ultra-loose monetary policy over the last decade is likely to disappoint this time around.
“… until recently, we lived in a low-inflation world that gave central bankers tremendous latitude to come to the market’s rescue,” Almeida says in the note. “With inflation running in the mid-single digits and lower income cohorts having to choose between putting gas in their cars or food on their tables, we no longer live in that world. Inflation is becoming a political issue, and in the current environment, I think central bankers will need to act to aid Main St. (by reining in inflation) rather than Wall St.”
Similarly, Andy McCormick, T Rowe Price head of fixed income (and chief investment officer), says while the Ukraine war will “almost certainly complicate the already difficult task that central banks were facing trying to battle inflation”, higher rates remain the odds-on bet.
“At this point, we believe that central banks will proceed as planned and rates will begin to increase in March,” McCormick says. “The picture will be a little more difficult to ascertain as the year rolls on and will really depend on how negotiations and the conflict play out.”
Nonetheless, he says the central bank “pivot” to higher rates remains “extremely logical” with markets set to endure more volatility and rising investor appetite for fixed income.
“In recent history, Treasury yields in the 2% to 2.5% range and high yield bond spreads of about 500 basis points have been extremely attractive to investors,” McCormick says. “We expect that over the course of the year that those levels will be reached and that clients will become extremely interested. So our outlook over the full course of 2022 is that there will be growing interest in bonds as the year rolls on.”
US 10-year bond yields dipped to just under 1.74 per cent last week after briefly breaching the 2 per cent threshold in February before the Russian invasion.