Trading Inflation for Full Employment
It appears that the central bank is poised to act “responsibly irresponsible” with respect to monetary tightening, to use a term from Paul Krugman’s 1999 essay Thinking about the Liquidity Trap. If the Federal Reserve (Fed) continues to be extraordinarily reticent in confronting inflation proactively, remains overly concerned that underemployment is firmly entrenched, and stands prepared to let the economy run a little hot, tolerating some inflation in exchange for extended, low unemployment, then we believe a material change in both perspective and positioning is warranted for credit portfolios.
Protecting against Interest Rate Risk
Both emerging market credit—hard assets and especially local currency—and higher real-yielding sovereigns may offer better protection against a dovish monetary policy stance. As well, low-quality credit, including fallen angels, single Bs, and even select CCCs, may afford the most attractive opportunities in the global fixed income markets (see Charts 3 and 4). When analyzed using a historical perspective, these credit and emerging market opportunities are particularly apparent.
All of these positions—emerging market and single B credit—can reduce the sensitivity of a fixed income portfolio to a central bank that wants to act “responsibly irresponsible.” We believe minimizing this key risk—monetary policy “irresponsibility”—in credit portfolios is best achieved through shorter duration, mid-tier credit and select non-dollar sovereign exposure. However, further steps may need to be taken to reduce interest rate sensitivity, such as using short positions in developed market sovereign bond futures to further remove interest rate risk while bearing select emerging market high, real-yielding local currency risk. Given these exposures, our credit portfolios will have a decidedly non-benchmark orientation. This benchmark-agnostic approach also happens to be a Brandywine Global philosophy and hallmark.
Groupthink is bad, especially at investment management firms. Brandywine Global therefore takes special care to ensure our corporate culture and investment processes support the articulation of diverse viewpoints. This blog is no different. The opinions expressed by our bloggers may sometimes challenge active positioning within one or more of our strategies. Each blogger represents one market view amongst many expressed at Brandywine Global. Although individual opinions will differ, our investment process and macro outlook will remain driven by a team approach.