My name is Kyongsoo Noh, and I am a portfolio manager on the ultra-short duration team at J.P. Morgan Asset Management. We are pleased to present the 2021 Q3 Guide to the Markets audio commentary for Global Liquidity investors.
We find ourselves at an interesting juncture in the US recovery from the pandemic. Since the equity markets trough of March 2020, we have seen tremendous improvements in economic output, the labor market, and prices – but the recovery of these three things are going at different paces. The challenge now for the Federal Reserve (Fed) is how to manage monetary policy when we have nearly closed the GDP output gap due to the pandemic, but we are still well short of full employment while at the same time, inflation is already running hot.
Let’s look at the dynamics and interplay of these forces in more detail.
We start on the left side of p. 20 of the Guide, which is a chart of real GDP over time quoted in 2012 dollars. The solid line is actual growth, and the dotted line is trend growth over the last 5 years. Based upon the strong economic performance thus far this year, we expect US actual growth to return to the trend line by the end of 2021, which will officially close the output gap due to the pandemic.
• Our forecast for Q2 GDP annualized growth is 10%, which means the right side of the V in the solid actual growth line should surpass the pre-pandemic peak of Q4 2019 once the Q2 data is released later in July
• We also expect growth for the full year 2021 to be between 7 and 8%; therefore, the solid line should reach the dotted trend line by the end of this year, thereby closing the output gap caused by Covid-19
• This is no small feat considering that the output gap due to the virus was over $2.5 trillion
• Looking forward, growth next year should be positive but not as strong as this year; in fact, the 10% growth rate we expect for Q2 will likely be the peak in this cycle
• Keep this idea of peak growth in the back of your mind until we share some thoughts on inflation later in the commentary
• Overall, economic output is on the verge of fully normalizing
Now let’s go over some thoughts on the labor market. In general, while there has been a tremendous recovery in the employment sector, we are still short of a full jobs recovery.
• Before we get to the charts on p. 27 of the Guide, it’s not on this page but at the jobs trough in April 2020 we had lost 23 million jobs due to the pandemic. We have recovered 16 million jobs since then (including 850k jobs in June), leaving a 7 million jobs deficit. On top of that, we will need another 1 million or so jobs for the new workers that have entered the labor force.
• Against this deficit, on the left chart, we have over 9 million job openings, which is the most ever. At the same time, as you can see on the upper right chart, employers are finding that now is also the hardest time ever to fill those openings.
• Two frequently mentioned near term barriers to hiring are that (1) enhanced unemployment benefits are in some cases more attractive than what current jobs are paying and (2) some workers are having trouble finding affordable child care
• These hurdles should diminish by the fall as (1) the benefits program as a whole expires and (2) schools fully reopen
• However, even with some of the near term hiring challenges dissipating, some medium term hurdles remain - we are still figuring out what the post pandemic economy and workplace are supposed to look like, and there is still a skills shortfall for the very best jobs
• As such, we do not believe the 8 million jobs gap will be closed before the middle of 2022
• Therefore, our base case for Fed hikes is the first quarter of 2023, which gives the Fed some time to digest a full jobs recovery before raising rates; of course, if labor outperforms to the upside in the interim, that may move forward our call on liftoff
This brings us to inflation which is pictured on p. 30 of the Guide. We just went over how GDP is just about on track and labor is undershooting. By contrast, inflation is already running hot. While I do think inflation is currently peaking and will fade within a couple quarters, inflation should still settle into a higher level for this economic cycle than where we saw it in the decade following the Global Financial Crisis (GFC).
• In the upper right table, whether you are looking at headline or core, CPI or PCE, price increases YoY are running between 3 and 5%, which is well above the Fed’s target of 2%
• Inflation is running hot because of base effects, fiscal stimulus, supply constraints, and rising home prices
• The 3-5% figures may persist over the next couple of quarters, but beyond that, we should see it start to decelerate, mainly because as I mentioned earlier, Q2 should mark the high in GDP growth for this economic cycle
• Furthermore, the medium term forces that kept inflation down in the 2010s are still in effect today, namely: globalization, technology and low population growth
• Having said all of that, after we see inflation come off the current highs, inflation should still be stronger in this cycle than in the 2010s because we have more fiscal stimulus now and unlike after the GFC, consumers today are spending it rather than using it to repair their balance sheets
• With higher inflation, the Fed has taken notice and is taking action
In fact, the Fed started the road to less dovishness two weeks ago when they acknowledged the uptick in inflation and published a dot plot pointing to two hikes in 2023 - to see this, I direct you to the dark blue diamond on p. 37 of the Guide. In the prior dot plot from March, the median dot showed no hikes until 2024. In their own words, the Fed is also now “talking about talking about tapering.” Our expected Fed roadmap is as follows:
• The Fed formally announces a plan for the tapering of the QE program in August at the Jackson Hole symposium
• The Fed officially starts taper in December of 2021, at a pace of $10 billion per month, which will wind down the program in a year
• US GDP fully recovers the output gap including lost trend caused by the pandemic by the end of 2021
• By early 2022, inflation starts to abate from the current 3-5% peak level but eventually settles somewhere above 2%, which is higher than it was in the decade after the GFC
• The labor market recovers the 8 million jobs needed to close the employment gap by the middle of 2022
• The Fed starts to hike the Fed Funds Rate in Q1 of 2023
Needless to say, there are a lot of moving parts to this roadmap and there is no guarantee that it will happen as prescribed but overall it does point to continued rate volatility and a further steepening of the rates curve in the coming quarters.
There are number of ways to navigate our Fed roadmap in the liquidity investing space. The key is to weigh your desire for higher returns against your risk tolerance and your investment time horizon. To explore these topics further, please reach out to your J.P. Morgan Asset Management representative. Thank you for listening, and we look forward to speaking with you.
Sources: J.P. Morgan Asset Management, Bloomberg
Hi, this is James McNerny, portfolio manager on our Managed Reserves, or ultra-short duration team. We hope you’re well, and that your summer is off to a great start.
The second quarter of 2021 was an eventful one for markets, including the front end of the curve and ultra-short strategies. Risk assets generally moved higher across asset classes given the positive macroeconomic backdrop, the continued reopening and roll-out of vaccinations, tailwinds from fiscal stimulus and better-than-expected corporate earnings. In fixed income, longer term yields fell, taking back some of the sharp rise seen earlier in the year, with the nominal 10yr rate moving around 30 basis points lower from 1.74% to 1.47%. Some pundits pointed to a reduction in inflation expectations as the catalyst for this move, but with 10 year inflation breakevens roughly unchanged over the quarter, it appears to us to have been more technically related as investors took profits on short positions and curve steepeners they implemented in prior quarters.
In the ultra-short space, Treasury markets were largely subdued in April and May as the bellwether 2yr traded in a tight range of just 4bps, with an average yield of around 16 basis points. With rates muted, spread sectors produced solid returns for the first two months, as credit spreads tightened from their wides seen at the end of the first quarter in late March. As a result, longer fixed rate credit outperformed both shorter credit and Treasuries in April and May.
But we did have some early summer fireworks mid-June in the form of the outcomes from the Federal Reserve Open Market Committee meeting on June 16th. The tone of the communication from the committee was notably more hawkish (or some would say less dovish) than it was at their March and April meetings, setting the committee up with increased flexibility for monetary policy in the second half of the year. In essence the Fed seems to have acknowledged that the economy may need less support from monetary policy than they previously thought. Particularly noteworthy were two items. First, Chairman Jerome Powell in his press conference said that the committee had begun a discussion around scaling back their $120 billion in monthly bond purchases, a process better known as tapering. You may remember that in the past Chair Powell said they had “not begun talking about talking about tapering,” but this time he retired that phrase, specifically noting they “began talking about talking about” reducing the pace of bond purchases, saying the economy has clearly made progress. There are a number of market implications to the taper of asset purchases, but the one most impactful to the ultra-short space is that it’s understood that taper needs to be completed before the Fed will hike rates. And to that extent, the other significant change in communication was the FOMCs release of their Summary of Economic Projections (or their dot plot), which showed a median projection of 2 hikes in 2023, versus the prior release in March which showed none. This was somewhat surprising relative to what the market was pricing. Rates in the front end moved higher, with the 2yr piercing through the prior well-defined range, reaching a high of .27% before closing the quarter at .25%. These moves caused longer maturity Treasuries and corporates in our space to underperform in June, while securities inside of 1yr fared relatively well.
Overall, the tightening in credit spreads that took place earlier in the quarter was enough to overcome the move higher in interest rates, and credit, particularly longer fixed credit, outperformed Treasuries across the curve in our space.
Our thesis for ultra-short portfolios here at JPMorgan for some time has been to maintain an overweight in credit vs Treasuries, and we had been reducing our exposure to Treasury duration generally prior to the Fed meeting given the low absolute levels of rates and our view that a back-up could be in the cards. And with the majority of our portfolios concentrated in maturities inside of 1yr, portfolios in the peer group were resilient in the face of the move higher post Fed. Following that move, we did take the opportunity to actively add back some Treasuries given our view that the move had shifted the market into pricing a policy path even more aggressive than what the Fed is indicating in their dot plot. That made Treasuries appear cheap to us for the first time in a long time. We now believe we will likely be in this new, higher range for the coming months, and will look to actively exploit the opportunities it presents.
In credit, we continue to be positioned overweight, primarily in investment grade corporate bonds. Despite the historic tightness in spreads, we are constructive on technicals in the space given the flows we’ve seen (and continue to see) into the category year to date as well as the $4.5 Trillion dollars in US dollar money market funds. Those funds have net yields in the mid to low single digits, resulting in a continued search for yield from clients willing to step out slightly on the curve to seek more yield but not taking on too much duration. In fact the ultra-short category broadly is in the top 10 of actively managed strategies in the industry for net new flows year to date. That shift continues to provide support and liquidity to the market. In addition to technical, we continue to be constructive on credit fundamentals given strong balance sheets and earnings in the reopening and a generally strengthening macroeconomic landscape. One subsector that we have been adding to positions where allowed is selectively in the AAA tranches of collateralized loan obligations. The positive correlation with the improving macroeconomic landscape, diversification of the underlying pools of borrowers in the deals we buy, the strong credit support the structures afford us and the attractiveness of spreads and overall yield levels all make the sector attractive to us at this juncture.
Looking forward, we’re excited by the prospect of the Fed continuing to explore a reduction in monetary stimulus, as it will help to buoy yields in the very front end and ultra-short products. We anticipate an announcement of the Feds plans to taper in the coming months, with implementation beginning as early as the fourth quarter. That will hopefully allow the Fed to begin hiking rates in late 2022 or early 2023, which will help us to continue to add yield in what has been a yield-starved front end of the curve.
We feel confident in credit sectors broadly given the strong technical and fundamental backdrops, and will maintain our overweights, selectively adding to sectors that are relatively cheap. But none of our positioning is static and we will continue to actively trade portfolios in this space, as mentioned earlier with our duration trading in the second quarter. In fact, as we progress through the second half of the year it would not be surprising to us to begin to shorten our duration as we move closer to fed liftoff.
Should you have questions or wish to speak, please do not hesitate to contact your JPMorgan advisor who would be happy to put you in touch with us. In the meantime, thank you for joining the conversation, please take care of yourselves and stay healthy and safe.
Hi, I’m Jeff Schill, portfolio manager for our international ultra-short duration portfolios.
The 2nd Quarter of 2021 can be summarized in two main themes:
1) How would the world handle COVID -19 Variants, like the Delta variant or the next Greek symbol to come our way. ….More specifically the challenges faced by developing and developed countries reactions in the UK, vs India or Brazil for example.
2) What will be the market reaction to central banks withdrawal of stimulus and WHEN will it happen?
For those looking forward to a summer lull and quiet markets, you would have to keep searching….. as the 2nd Quarter of this year was dominated by rates volatility globally surrounding the hawkish June 16th Federal Open Market Committee meeting. The decline in long-dated US yields seen through Q2 as the market became increasingly confident of the notion of inflation proving transitory. These moves were felt globally as the 10yr German Gilts reached as high as -10 basis points but finished the quarter around -20 basis points and 10yr Gilts ticked up to almost 90 basis points before ending around 72bps.
As vaccination rates across the Eurozone increased, economies began to adjust to more transmissible variants of COVID-19. With much of the quarter still hindered by regional lockdown restrictions, upward GDP revisions demonstrated that the broad recovery seems unlikely to be completely derailed by new variants. Forecasts suggest GDP will rebound to pre COVID levels (and surpass) potentially by the end of 2021 resulting in better than expected Q2 corporate earnings.
For the UK, the notion of negative interest rates seems like a long distant memory compared to the rates volatility we witnessed in Q1. Throughout the 1st half of 2021, negative interest rates were quickly priced out, but importantly – this is now a part of the Monetary Policy Committee’s “tool kit” with operational readiness exercises completed should policy be needed at some point in the unforeseen future. The UK battled the Delta variant and delayed further reopenings to mid-July BUT with vaccination rates climbing in the younger population, economic activity should produce very large data prints to start the 3rd Quarter. The MPC has adopted the “wait and see mode” and with the potential for curve steepening ahead we see a decoupling in monetary policy from the European Central Bank (ECB) and look for tightening sooner.
At its June policy meeting, the European Central Bank revised up its growth and inflation forecasts for 2021 and 2022, BUT more importantly did not alter policy and re iterated a “steady hand”. The continued dovish stance points to the central bank’s pledge to keep base rates low and liquidity high which continues to anchor short term EURO rates. Despite volatility further out the curve, the EURIBOR curve remains very flat, with a large amount of maturity tenors regularly fixing below the ECB Deposit Rate.
Despite upward revisions to inflation, the Eurozone will still fall short of the ECB new target of 2%. Headline inflation certainly grabbed headlines throughout the quarter but long term core inflation remained subdued providing further support of continued ECB accommodative measures. As we look beyond the second quarter, all eyes will be on the ECB’s 2H21 Strategic Review where there will be potential changes to monetary policy like from Pandemic Emergency Purchase Programme into potentially adapted asset purchase programme and additional Targeted long-term refinancing operations by the end of the year will still remain supportive.
As we look to the end of the first half of the year, we find ourselves at a crossroads between strong fundamentals, supportive technicals, tight valuations, lockdown restrictions lifting and combatting COVID variants. With Central Banks continuing to be accommodative near term, forward guidance is pointing to rates (and front end yields) remaining unchanged for at least a couple of years. Navigating choppy rates volatility is likely to continue to hamper summer holidays but perhaps in the second half, we will see if the economic recovery is here to stay.
Welcome to J.P. Morgan Global Liquidity’s audio commentary. My name is Aidan Shevlin, I am the Head of the International Global Liquidity Fund Management Team, and today I will be discussing China’s economic and interest rate developments during the second quarter and the outlook for the rest of 2021.
Economic growth continued to moderate during the second quarter, albeit from previously high levels, as Covid-19 base effects faded from the annual numbers. Trade and manufacturing data remained relatively robust, but restrictive policy measures weighted on the important infrastructure and property sectors. Meanwhile, consumer sentiment and consumption were negatively impacted by a Covid-19 resurgence in southern China – although this has also encouraged a faster vaccine rollout. The government noted that the recovery remained uneven, while the central bank committed to a more neutral monetary policy stance, supporting a modest decline in interest rates and further flattening of the yield curve.
First quarter Gross Domestic Product jumped to a record high of 18.3%y/y due to base effects of the pandemic in early 2020. However, while the quarterly number remained positive for the fourth consecutive reading, it slowed to 0.6%q/q as robust exports failed to offset a moderation in domestic demand triggered by temporary Covid-19 restrictions over the key Chinese New Year holidays.
This more subdued growth persisted into the second quarter due to three factors. Firstly, the rapid vaccine rollout and reopening of western economies prompted a pivot from spending on goods to services – triggering an easing of developed market’s demand for Chinese exports which also impacted manufacturing and industrial production. Secondly, reduced government stimulus and slower credit growth as the authorities escalated their focus on deleveraging the economy, weighted on fixed asset investments. And finally, the recovery in domestic demand was dented by fresh Covid-19 cases in southern China and weaker than expected employment growth, which suppressed consumer sentiment.
In comparison to Western reflation fears, Chinese headline inflation remained relative muted throughout the second quarter as food prices, which represent a key component, actually declined. Concurrently, producer price inflation hit a thirteen-year high of 9%y/y on higher oil and commodity prices – although this, as yet has not provoked any pass through to consumer prices.
[Government and Monetary Policy]
Following recent Politburo meetings, the government noted that the recovery remains uneven and pledged to maintain support for fragile sectors. This message was echoed by the State Council, which called for continued economic stability, suggesting that significant adjustments to current fiscal policies are unlikely – although the authorities remain committed to structural reforms and implementing the new five-year plan. Several local Covid-19 outbreaks during the quarter also encouraged the authorities to accelerate China’s vaccine rollout with the aim of vaccinating the majority of the population by the end of 2021.
During the second quarter, the People’s Bank of China (PBoC) maintained its “prudent but stable” monetary policy, leaving its Medium Term Lending Facility and Loan Prime Rates unchanged for the fourteenth month. New PBoC open market operations throughout the quarter offset maturities, ensuring ample market liquidity; however, as part of an effort to calm the pace of renminbi appreciation, the central bank hiked their reserve requirement ratio for foreign currency by 200bps to 7%.
The moderation of economic data, combined with the government’s renewed focus on stability and central banks’ actions to ensure adequate liquidity all contributed to a reduction in interest rate tightening expectations. Bond and SHIBOR yields declined modestly during the quarter and the yield curve flattened. Repo rates were steady, trading in a relatively tight range throughout the period. Finally, the renminbi eased back from a three-year high, but remained one of the best performing currencies relative to the US dollar during the quarter.
By the end of the second quarter, Chinese economic data had normalized as the initial, volatile impact of the Covid-19 pandemic faded from the annual numbers. The economic boost from strong exports and supportive Western fiscal and monetary stimulus receded. Simultaneously, property tightening measures, lower money supply and partial lockdowns dampened domestic sentiment and demand.
Nevertheless, we believe the authority’s renewed commitment to stability and pledge to continued structural reforms should help reduce systemic risks and boost longer term demand, albeit gradually. In addition, the accelerated vaccine rollout will also support future consumption and consumer confidence as the risk of further lockdowns subsides.
Finally, with domestic inflation muted, we expect the PBoC to maintain a more stable and supportive monetary policy stance for the foreseeable future, implying that interest rates are likely to remain range bound at current levels.
(data source: Bloomberg and J.P. Morgan Asset Management, as of 30 June 2021)
Hello everyone, my name is Juan Lois and I’m on our dedicated Sustainable Investing team, leading our Clients Solutions for the Americas. Today I will walk you through what sustainable investing means for us at JP Morgan Asset Management, focusing on how we integrate financially material Environmental, Social and Governance factors into all our actively managed strategies.
Sustainable investing can mean something different to everyone, so I would like to first start with what it means for us. We use sustainable investing as the broad umbrella term for all investment strategies that consider Environmental, Social, and Governance factors in the investment process. At its core, sustainable investing is a forward-looking investment approach that aims to deliver long-term sustainable financial returns in a world that is changing rapidly.
This last part is key, as the world is fundamentally changing and at a faster pace than ever before, we must be forward thinking with our investment process. . Whether it is the rise of all types of goods and services produced in sustainable ways, or the proliferation of data that provides greater transparency on how companies operate – the world has and is increasingly shifting in ways that create additional E, S and G risks that we as investors have to consider in our investment process if we are to produce the same financial returns that our clients have always expected of us.
Said another way, at JPMAM we believe that explicit incorporation of financially material ESG information in the investment process can help deliver enhanced risk-adjusted returns over the long-term. Think of ESG as data. It is extra-financial information that can help us make better informed investment decisions. For this reason, over the last several years we have been very focused on making sure all our actively managed strategies incorporate ESG information in the investment process, which has resulted today in over $2 trillion in ESG integrated assets under management.
While we ensure each investment team aligns to a set of standards, we also make sure that each asset class and investment team has their own implementation process – which includes deciding exactly which ESG issues are financially material for their given strategy. This is critical as a risk from an equity perspective might be very different from a risk for fixed income products.
As we look at Global Liquidity and our money market products, they too consider the E, S and G factors that can impact a company’s ability to successfully operate and generate returns. Our credit analysts evaluate a range of ESG issues to better understand the extent to which the issuers we lend to on behalf of our clients can navigate and manage the ESG risks they face. This evaluation, which includes our own proprietary analysis as well as 3rd party research like MSCI, is reflected in our issuer recommendations and our approved purchase list – which directly impacts concentration and tenure parameters.
As part of our general research process, we actively engage issuers on all financially material risks – including ESG issues – and we incorporate the insight gained from these conversations with issuer management into our analysis and recommendations. Because of JPMAM’s size and the frequency in which we work with the same issuers, these conversations and resulting investment decisions can have a real impact on an issuer’s access to capital.
Looking ahead, we are building on the tremendous amount we learned from each of the investment teams during the ESG integration process and are creating a proprietary ESG score. The score will incorporate insights from our fundamental sector analysts, a range of external data sources, and new AI and data science capabilities to identify forward-looking ESG risks and opportunities.
We are also focused on going beyond ESG integration to build a suite of sustainable products that aim to better capture opportunities associated with the transition to a more sustainable future.
To wrap up, we are really excited about these efforts and the commitment from our entire firm. If you have any questions or if there is anything, we can do to assist you on your own sustainable journey, please don’t hesitate to reach out to your JP Morgan Asset Management Representative. Thank you.