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 Q4 Guide to the Markets audio commentary for Global Liquidity investors.
The US economy continues to rebound from the pandemic recession. Although economic performance in Q2 and Q3 were a little disappointing vs. expectations, growth overall remains strong. Inflation in particular is a standout and has recently caught more of the Federal Reserve’s attention. As a result, Chair Powell has skewed the most hawkish in his public comments since the pandemic began. We now anticipate taper to start in November 2021 finishing by next summer and interest rate hikes to start in either Q4 2022 or Q1 2023.
The key to investing the front end fixed income markets will be navigating this unwind of easy monetary policy. Today we will explore this change in Fed direction in more detail.
First we will quickly review the economy. On the left chart on p. 18 is real GDP growth over time.
• After the Q2 GDP print, we reached the milestone of surpassing the pre-recession peak level of real economic output .
• The recovery continues, and growth has been strong, but recent performance has been a little disappointing vs. expectations. Earlier in the year we were projecting 7-8% growth for FY2021 – now, it is looking more like 6%.
• The main driver of this recent deceleration in real growth this past quarter was the delta variant.
• At the same time, difficulty hiring workers and supply bottlenecks also limited growth plus they had the additional effects of higher prices.
• Let’s look a little closer at these drivers.
On the left chart of p. 19 of the Guide, we can see the third wave of the virus in the US, which was caused by the delta variant.
• It is understandable that during the summertime, there was some caution amongst public officials including Chair Powell about the delta variant. This is because of the experience in India, where some studies estimated that the actual cumulative fatality toll was approximately 4 million people, which is about ten times the published official tally (Source: WSJ 7/20/21).
• On the left chart, while we did get a surge of delta here in the US, from both the blue cases line and the gray fatalities line, it does look like the wave has crested.
• In due course, the uptick in US cases and fatalities due to this latest virus surge was significant enough to change behavior and curtail economic activity during the quarter (as demonstrated by the softness in the travel, leisure and hospitality sectors during August in particular, which can be seen on p. 20 of the Guide) but not enough to derail the overall recovery; and because of high vaccine and natural immunity (shown in the right chart of this p. 19), the experience here was not as dire as it was in India.
• With the delta wave now waning, one of the causes of Fed’s summer caution has faded, and Chair Powell in his latest press conference has hinted that they could start tapering as soon as November.
Versus last quarter, we in Global Liquidity are updating our Fed roadmap:
• Now, we expect the Fed to first taper in November taking 6-9 months, finishing by next summer.
• We see an equal chance that the first hike will be in either Q4 2022 or Q1 2023.
We made these updates based upon the Fed’s more hawkish public comments, but also upon changes in the Fed’s near term outlook:
• In the upper right table of page 31 of the Guide is the Fed’s Summary of Economic Projections (SEP) from September 2021, which point to near term lower real economic growth, and higher inflation.
• A reduction in the growth projection might normally warrant a more dovish response, not a hawkish one, but in this case, overall growth rates remain at relatively high levels that can still support a weaning off of easy policy, and more importantly, rising inflation is less tolerated while growth is decelerating instead of accelerating.
• As such, the Fed skewed more hawkish and we updated our Fed roadmap accordingly.
To be clear, the Fed update is not calling for an outright 1970s style stagflation, and nor are we. The moves were more subtle. So what are the drivers of the change? The first is the labor sector, which we have some pictures of on pg 25 of the Guide. In Q3, the tightness of the jobs market was a both a drag on the economy and a driver of inflation.
• It’s not on this page, but we are still about 2% below the economy’s full GDP potential. GDP growth comes from more workers and higher productivity.
• Any difficulty in hiring holds the economy back; as shown in the Small Business Report in the upper right chart, it is getting more challenging to hire workers.
• In fact, the current amount of job openings in the US has grown to nearly 11 million (left chart), which is a staggering 44% higher than the prior peak.
• Competition on the hiring side has pushed wage growth up to 4.3% year on year, which is a double aged sword.
• On the one hand, people with jobs make more and consume more, which is good.
• On the other, less employers can make hires.
• Seeing the rapidly growing job openings figure, the later appears to be more common place.
• Another interesting point from the left chart is the time to labor market healing. From the pandemic trough, it only took 11 months to get back to the pre-pandemic peak of job openings. From the GFC trough, it took almost 5 years to achieve the same thing. A slower healing of the labor market after the GFC is why it took 7 years for the Fed to first raise rates during the last cycle. This time hikes will come much sooner.
Like tight labor markets, supply constraints are another factor that is limiting growth and at the same time causing inflation.
• Limits on inventories hold back real economic activity, while at the same time causes prices to rise. This is because slower inventory stocking is a direct drag on the investment component of GDP.
• On these charts from p. 50 of the Guide, we can see that rising supplier delivery times (left chart) are leading to higher prices (right chart).
• In fact, whether you’re looking at headline or core, CPI or PCE, inflation is running between 3 and 6% (see p. 27 of the Guide), which are well above the Fed’s target of 2%.
• The reasons for these bottlenecks include port congestion, chip shortages, and labor constraints.
• Over time, we should see:
1. Increases in shipping capacity and semiconductor fab utilization rates, which should help with the supply picture over time.
2. The waning of delta plus the expiration of enhanced unemployment benefits should also help with the labor picture.
• But even with these improvements, base effects make outsized GDP gains more challenging mathematically going forward. Ultimately, the Fed has started to show more uncomfortableness with these acute near term pricing pressures especially in the face of decelerating (albeit strong) growth, and turned more hawkish.
This most recent hawkish turn by the Fed has taken the rates market a little by surprise.
• This has caused an overall sell off and a steepening of the rates curve, hurting holders of longer duration products.
• In the left table of p. 34 of the Guide, you can see the underperformance of 10 and 30 year US Treasuries, but even 5s are not immune to negative returns YTD.
• Due to their lower duration risk, liquidity strategies have been less affected by these moves, and can be a decent holding not just for on-the-run liquidity purposes, but also for tactical reasons in a period of rising rates.
• Now, can this reverse? It’s not our base case, but staff changes at the Fed could potentially cause a return to dovishness
• Chair Powell’s term expires in February 2022, leaving the possibility of seeing a new, more accommodative chair next year
• In addition, recent resignations by Kaplan and Rosengren, two hawkish voices on the FOMC, also will give the administration an opportunity to tilt the committee more dovish should they desire to.
• Regardless of any staff changes, if Chair Powell initiates the taper process in November, it would be difficult for a new chair to change tapering mid-course; Instead, a dovish tilt to the FOMC would more likely be felt in the hiking process.
In summary, because of the Fed’s recent hawkish turn, we now expect taper to start in November 2021 finishing by next summer and interest rate hikes to start in either Q4 2022 or Q1 2023. As a result, we do anticipate a continued steepening of the rates curve, which does put downward pressure on the returns of longer duration fixed income strategies. However for liquidity investors, with hikes not imminent, it also unfortunately means that a rise in net money market fund yields is at least a year away.
The key to navigating the front end space is balancing carry and duration against liquidity needs. 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.
UK & Europe Q3 in Review: UK Ready to Hike whilst Europe Takes a Different Path
Neill Hutchison, lead portfolio manager for our international ultra-short duration funds, provides an update on the current market environment in UK and Europe and how it impacts investment strategy.
Hi, I’m Neil Hutchison, lead portfolio manager for our international ultra-short duration portfolios.
Emerging from the global pandemic was never going to be plain sailing and the third quarter of 2021 certainly posed many challenges. From the delta variant forcing further lock downs in Asia, to signals global growth could be waning, to supply bottlenecks, well .. getting worse (not better!) and related to this … concerns that … “transitory inflation” we’ve been hearing about ALL YEAR may in fact be less “transitory”. On top of all this Geo political concerns have also picked up.
So, any hopes we had of enjoining the summer lull were quickly dispelled. For front end rates markets, by now used to rock bottom yields and flat curves – almost in a state of paralysis … well … even some of our markets started to show some signs of life, especially in the UK. So the usual message of “nothing to see here” so often telegraphed for the front end has shifted to the message “The Bank of England is in Play” …
From pricing 2021 rate CUTS at the start of the year to pricing the potential for 2021 rate HIKES – the post Brexit, UK economy has been interesting to say the least. Growth and employment data has been printing better than expected and with the bank keeping a “close watch” on inflation expectations, its clear the Monetary Policy Committee (MPC) has taken a more hawkish turn as we enter into the fourth quarter of the year. At time of writing, the market is pricing a 50% chance the MPC will hike, at its next meeting in November. Whilst many believe a 2021 hike is premature, current market pricing is probably fair considering the BoE told us in September they could hike, if required, before QE finishes in December. Were they in fact telling us there is a non-zero chance of a November hike?
So whilst GBP front end investors look forward to the prospect of higher rates .. as well as steeper curves, the outlook in Europe remains stubbornly familiar with very little changes expected in front end rates for the foreseeable future.
Despite the announcement of a “moderate” reduction in the pace of the PEPP programme at the September meeting of the European Central Bank (ECB), the message from the Central bank was one of caution, framing the ( .. headline grabbing) Pandemic Emergency Purchase Programme (PEPP) adjustment as a recalibration rather than a taper. We agree the move to adjust the Pandemic support programme should NOT be seen as the first step towards a normalisation of monetary policy. When we consider the ECB’s latest staff projections in which they forecast core inflation at only 1.5% in 2023 (well below the 2% target) , this is hardly a forecast that is indicating the ECB should be even thinking about hiking rates, on the contrary one could view the ECB as still having an “inflation problem” .. that is … its too low … not too high.
With this in mind, Madame Lagarde highlighted in the December ECB meeting as the point in which big decisions will need to be made on the future of the PEPP, Asset Purchase Programme (APP) and Targeted Long-Term Refinancing Operations (TLTRO) programmes; all of which could have implications even for front end rates. The market consensus view is … if PEPP gets wound down the APP, which currently is buying assets at a pace of EUR20bn per month, will likely be upsized and potentially remodeled to fill a large part of the void.
Considering the next “big decisions” from the ECB will not be announced until December, the October 28th meeting of the governing council could well be viewed as a bit of a “non-event”, however with European inflation not expected to peak until Q4 , any shift in tone, especially surrounding inflation expectations, could become market moving.
We expect little change in front end European rates and money market yields during Q4 but await with baited breath the December announcements as APP, PEPP and TLTRO can all potentially impact front end spreads. This said, considering the ECB’s inflation outlook, our base case would be for continued QE support , sizeable excess liquidity and forward guidance making it clear rates will remain LOWER FOR LONGER.
To summarize , the final quarter of 2021 will be interesting from a European perspective, we have a hawkish BoE either pulling the trigger on their first hike since 2018 (or at least setting the scene for a Q1 2022 hike) and a less hawkish ECB forced to take a different path due to their perennial inflation problem. One thing the ECB and BoE have in common, … as we look out into the future, is we may be expecting higher rates but … the amount of hiking, or the terminal rate, appears relatively modest. Looking at forward curves, current market pricing sees the UK’s bank rate peaking at 1% and the ECB’s at 0% both in around 5 years’ time.
The low for longer narrative may well now just be the new normal. With rates remaining potentially “lower for ever” and balance sheet cash structurally higher, cash segmentation strategies that can lift returns from 20 to 60bps, depending on the strategy, could warrant a closer look even after rates “normalize”!
By the end of the third quarter, multiple impediments had weakened the pace of China’s recovery.
Fortunately, China was able to quickly contain the recent Covid-19 outbreaks and ease lockdown restrictions, which should support a rebound in consumer sentiment and consumption. Having said that, there appears little incentive for the authorities to deviate from their zero-Covid strategy. This implies international borders will likely stay closed and the risk of disruptive lockdowns remains a possibility for the foreseeable future.
In addition, the latest headlines on power shortages are a concern and the Government’s commitment to its strategy of deleveraging the property and shadow banking sectors implies further economic volatility and elevated market risks are likely.
Nevertheless, industrial production, manufacturing and exports are still robust and the authorities’ recent pivot to a more dovish fiscal policy stance should alleviate systemic concerns and keep the economy on track to hit the government’s 2021 GDP target. It will also allow the PBoC to implement additional interest rates cuts and inject extra liquidity if necessary, suggesting short tenor interest rates are likely to trend further downwards.
Thank you all for joining the conversation today. Should you have any questions, please reach out to your J.P. Morgan Asset Management representative.
(data source: Bloomberg and J.P. Morgan Asset Management, as of 30 September 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.