A rapid increase in interest rates across the US, Eurozone and the UK has led to them being, broadly, at their highest levels for the last 20 to 30 years.
But headline inflation in all three of these economic regions is now falling, albeit that progress has been different in each. Yet core inflation appears to be proving somewhat ‘stickier’ and overall progress to their respective inflation targets has slowed somewhat, leading all three of the central banks (US Federal Reserve, the European Central Bank and the Bank of England) to suggest that rate cuts are unlikely any time soon and that further increases cannot be ruled out.
At Invesco, we believe there are unlikely to be material further rate rises from here but agree cuts may not be on the table until at least Q2/Q3 2024.
Yields, net of fees, on our AAA-rated low volatility net asset value (LVNAV) MMFs sit at approximately 5.5%, 3.8% and 5.3% across USD, euro and GBP respectively.
... Labour markets are tighter than would be expected in what is a slow growth environment, putting upward pressure on wages and feeding into inflation
The large and fast rise in interest rates is already causing ripples across assets markets as investors seek to understand where problems might arise. For instance, will there be another banking crisis? A year ago, we witnessed SVB, which, because of central bank intervention, remained a contained impact on medium-sized banks in just a relatively small region of the US. Or will the global economy go into a recession?
Will government bonds (normally seen as a safe haven) continue to drop in prices, especially in the longer end of the yield curve from 10yrs+? Central banks face some potentially difficult choices if inflation does not fall back to target quickly enough, so could they increase interest rates more aggressively and induce a strong global recession?
It appears that post the COVID-19 pandemic and with ongoing demographic/migration patterns, labour markets are tighter than would be expected in what is a slow growth environment, putting upward pressure on wages and feeding into inflation.
In addition, we are seeing an increase in geopolitical issues that could, apart from the concerning impact on humans, make the current job of central banks even trickier.
So, it is difficult to predict how the period we are in will unfold. Some compare it to the stagflation of the late 1970s to early 1980s, but a key difference now is the size of central bank balance sheets, which are very large due to government bond purchase schemes to deal with both the Global Financial Crisis and more recently the COVID-19 pandemic. These are important to risk asset markets and as central banks are now shrinking their balance sheets (in an effort to tighten financial conditions, to assist in taming inflation) they are incurring losses that governments will likely, ultimately, have to pick up the tab for.
In addition, government spending has also increased materially so fiscal support is perhaps more constrained from here. In addition, economies such as China, are now very different and can have potentially a large impact on the global picture.
That said, we do not believe we are heading into a deep global recession and if anything, are more optimistic that we can navigate a smooth, but perhaps narrow, path to a more stable growth trajectory. That view is now becoming quite a consensus and is why we continue to adopt a very conservative approach to our investment decisions for our MMFs.
With MMFs running at very low duration (the maximum allowed is 0.16 years) and very conservative credit risk, maximum flexibility on trading your cash positions and access to your funds on a T+0 basis should at least be one less thing to worry about.
Paul Mueller is head of global liquidity, EMEA portfolios, at Invesco
