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    US pension market quarterly

    US pension market quarterly

    A statistical and qualitative review of Q2 2021 and investment outlook

    Download the full report.

    After a sharp upward move in yields during the first quarter, yields drifted downwards in the second. 

    Minutes from the June Federal Open Markets Committee (FOMC) meeting suggested tapering could occur later this year, with the median forecast of FOMC members expecting 50bp of interest rate rises in 2023. 

    With regard to interest rates, we continue to believe the FOMC will remain on hold for a considerable time yet but accept that longer maturity bond yields may experience periodic bouts of volatility as markets look for yields to return to some historical ‘norm’. 

    • Inflation has accelerated in the short term, but we believe this will prove transitory, which should release pressure on the FOMC over the medium term

    • With the economy recovering rapidly, the earnings outlook has improved and the credit cycle is back. Given this, we would be cautious on single A rated credits, which we believe are likely to be under greater pressure to increase leverage
    • Taper talk has gripped markets, but liquidity is so abundant markets are struggling to absorb it all. We believe this should limit the impact of tapering on credit markets in this cycle
    • Key risks include markets already priced for an optimistic scenario and the potential for those companies that best survived the crisis to leverage up to pick off weaker players
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    Fasten your seatbelts. It's going to be a bumpy ride.

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    Fasten your seatbelts. It's going to be a bumpy ride.

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    Margo Channing, All About Eve
    Inflation triggers taper talk

    Headline CPI accelerated to 5% year-on-year, the fastest since 2008. Core CPI also substantially beat expectations at 3.8%, the fastest since 1992. However, we believe the uptick in inflation will prove transitory, and inflation will begin to decelerate as base effects and short-term bottlenecks dissipate.

    Categories like used car prices can only sustain the huge rises we’ve seen for a limited time, and without a sharp rise in prices elsewhere, it will be very difficult for 5% inflation to be sustained.

    That said, we expect the descent in CPI to be slow, and that it will be several months into 2022 before the year-on-year rate of inflation moderates to below 3%.

    In Figure 1 below:

    • The dotted blue line indicates the path of monthly inflation assuming we return to three-year pre-COVID CPI trends.
    • The dotted green line is a risk case, indicating the path of inflation assuming used cars, rental cars and air fare prices continue to rise for the next few months (which we view as unrealistic).

    We find that even if the volatile CPI elements continue accelerating (all else being equal), overall inflation would still fall over the next several months as headwinds from base effects kick in.

    Figure 1: The peak in year-on-year inflation may already be here

    Any meaningful sell off is an opportunity to add duration

    We believe patience and level-headedness will reward investors in the end. While we now anticipate an initial rate hike in 2023, we believe the Federal Reserve will stick to its guns in describing inflation as ‘transitory’ and do not expect a shift from its accommodative policy stance in the near term.

    We also believe that any volatility in bond markets driven by inflationary fears in the coming months could provide fixed income investors potential opportunities to turn such volatility to their advantage by adding duration on any meaningful sell off.

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