If your portfolio has let its allocation to fixed interest drop over the past few years, it’s time to rebuild.
Long-term inflation expectations suggest a recession is not an essential ingredient for containing inflation.From here, views on the outlook are sharply divergent, with fat-tail risks of geopolitics and stagflation. But with inflation over 8 per cent in the US, Europe and Britain and peak hysteria about high oil prices, tight jobs markets and ever-more hawkish global central banks, it’s easy to forget that a large swathe of that inflation is a by-product of the pandemic.
It is true that central banks globally are likely to deliver rapid-fire rate rises in the next few months, lifting policy rates close to 2 per cent offshore . But these, and further rises, are largely expected and reflected in market pricing.While there’s a risk that rising costs of living and wage growth will create an inflation spiral that may prove more difficult than expected to reverse, long-term inflation expectations remain broadly anchored .
For portfolio construction, the past decade has been difficult for fixed income and those seeking a decent component of regular income. Yields at the “shorter maturity” one- to three-year part of the interest rate structure have been near zero, and 10-year bond yields below 1 per cent have meant such investments looked “expensive” as they did not reflect the risk interest rates would eventually need to rise significantly .
However, markets have factored in enough policy tightening to make central bank policy restrictive if needed. Both the RBA and the US Fed are priced for cash rates around 3 per cent next year, and 10-year government bond yields have also risen to about 3 per cent. Indeed, with bank credit spreads widening, senior unsecured major bank bonds are yielding 3.5-3.75 per cent in the secondary market.
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