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For today’s soundbites, we look to the future with Terry Moore, vice president of T. Rowe Price Group and the portfolio specialist in the company’s fixed income division. We talk about where inflation, interest rates, and corporate credit levels are headed, and we started by asking what we can expect from the markets into 2022.

Terry Moore (TM): We expect economic conditions to improve as we head into year-end and into 2022. As we speak today, in late August, several economic numbers are actually surprising to the downside but I would say that forecasting in today’s numbers is a very tricky endeavour because of all of the noise from Covid last year. However, as more people are vaccinated, as children return to school, people return to work, we expect the economy to continue to improve. Growth and inflation are going to remain at higher levels and we should expect interest rates, generally, to rise around the world, get back to normal. We think credit can continue to perform well because we don’t see a major recession anywhere. But on the other hand, we do expect some volatility. So, we believe that investors should, one, be prepared for the volatility and, two, be prepared to take advantage of the volatility. And that means having flexible active management to both mitigate the risks, and have the liquidity to take advantage of it.

What is he hearing about inflation?

TM: Well, we could see inflation numbers stay a little bit higher than what we’ve experienced in the past. And there is a big debate in the market if inflation is going to be transitory or more structural and durable. Transitory would be it’s here in the near term but they expect it to pass as some of the supply shocks get worked out. Structural inflation would be we’re at a steady state of higher inflation, wages go up but they stay at higher levels. That’s not what most economists are calling for. It’s not what we’re calling for, but the inflation could definitely be a number that is greater than what we experienced over the last 10 years.

Why this round of inflation is unlikely to run away from us.

TM: The economy is much different than the 1960s and 1970s, when we last saw runaway inflation. And the difference is that the ability for individuals to negotiate wages, that power is weaker today than it was in the 60s and 70s. One thing that is a little bit different, relative to the 2000s, is that the fiscal governments around the world are actually spending money today, whereas coming out of the GFC in 2008, federal governments around the world were basically in austerity mode. Today most central governments are spending money as we come out of the pandemic. So that’s something that folks who are worried about inflation being a little more structural they point to that. But for the most part, investors are expecting inflation to be transitory and work itself out over the next several months.

Where interest rates are headed.

TM: We expect interest rates to rise from these historic low levels and believe that many investors may benefit from taking an active duration posture. So that would be either shorter or underweight duration stance. Over on the credit side, valuations are rich today, but we don’t see a negative catalyst on the horizon to cause a mass of defaults. So, we are maintaining our credit exposure, albeit at lower risk levels than last year. Specifically, we like global high-yield credit, we like bank loans, we like some emerging market corporate credit — you have to be selective. We’ve recently added U.S. agency mortgage-backed securities as a high-quality liquid sector. They’ve recently cheapened as the market expects the Fed to begin tapering in the next several months, and they’ve become more attractive as a result of that, so we’ve added that to the portfolio as well.

And finally, who is likely to hike first?

TM: We’ve actually already seen some central banks around the world hike. The Czech Republic, Hungary, Sweden, Russia, Mexico, Brazil… they’ve actually already hiked rates. And it comes from a number of reasons. It could be growth and inflation already returning. Their economies reopening and so their central banks need to get hold of that inflation, and they’ve hiked. Certain central banks may want to protect their currency. Other central banks, like Russia, they’ve done very well with oil, so they’ve seen the need to hike rates there. However, the major central banks, before they hike rates, they’re likely going to remove some of the extraordinary bond purchase programs or quantitative easing programs that have been put in place first. In order of the majors, we’ll likely see the U.K., or, you know, the Bank of England, the Bank of Canada will probably hike a little before the U.S. does. The U.S. is probably not hiking until 2023. And then the ECB will probably stay on hold the longest of all the banks, due to demographics and other structural issues in Europe.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.

Our thanks again to Terry Moore, vice president of T. Rowe Price Group. Join us every Wednesday at InvestmentExecutive.com, where you can sign up for our AM newsletter and never miss another Soundbite.

Thanks for listening.

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