By Jon Jonsson, senior portfolio manager – global fixed income, Neuberger Berman
As the Federal Reserve meets today, movements in US inflation remain the most critical factor for markets. We agree with market consensus that inflation measures will start to decline, as some key drivers of higher inflation – particularly car prices – start to moderate.
However, we think the declines in inflation will be shorter-lived and shallower than expectations. The key reason is housing inflation. We expect persistent levels in this area, as well as pressure from wages on other goods and services. As a result, inflation could easily remain at 3% or more throughout the year.
With the Fed tapering decision out of the way, the market is pricing in an aggressive March start of interest rate hikes. We expect three 25bps hikes in 2022. The hiking cycle in 2022 will be much more about ending ‘emergency’ policy than attempting to significantly slow global growth. This is about a partial return to pre-Covid policy, rather than anything more significant. As such, we do not expect fundamental changes in the global growth environment.
In terms of positioning our fixed income portfolios, we are maintaining defensive interest rates positioning – particularly in the US. We expect the bond market to reprice the Fed’s terminal rate, as growth and inflation exceed the Fed’s targets. We believe a repricing toward a 2.25% terminal funds rate – from 1.75% currently – is a reasonable expectation. This would likely imply a 10-year treasury note target of approximately 1.85-2%. Given the ECB will be on hold in 2022, we believe defensive positioning in US rates will likely be appropriate in the near term.