“My favourite things in life don’t cost any money. It’s really clear that the most precious resource we all have is time.” Steve Jobs
The dominant global theme for 2022 and 2023 is increasing vaccination rates backed by record fiscal and monetary stimulus. This is further supported by strong household balance sheets and pend up demand.
However, we should not underestimate the pervasive risks around the delta strain or further unknown strains, and the emerging evidence of the need for boosters for some vaccines. As for unknown strains, a new variant has been detected in South Africa. C.1.2 was first detected in May but Delta is still the dominant variant spreading in South Africa and the world.
In terms of interest rates, changes in macro themes over the past week could start to impact on economic policy going forwards. One major casualty recently has been the AUD which fell over 3% on the back of a dramatic fall in iron prices and concerns over China’s economic slowdown. The weaker AUD of course is music to the RBA’s ears which has been worried about a strong A$ for quite some time.
The current market view still is that the Fed will begin the taper of its bond purchases in early 2022 (the Fed is currently still buying US$120 billion per month!) which will be stabilising its balance sheet by around mid-year. That will be in anticipation of its first increase in the Federal Funds Rate in December 2022. Bond markets will need to anticipate the curtailment of the policy (QE) that has distorted bond rates with deeply negative real yields. As broadly indicated by various measures including professional forecasts markets are comfortable that the FOMC and the RBA will achieve their inflation targets, but bond rates are being weighed down by unsustainable negative real yields particularly due to the Fed’s QE program – see chart below. The purple bars signify the Feds QE program during the past 2 years with the huge spike caused by the collapse in financial markets on the back of the COVID-19 outbreak last year.
It is hard to change things up for investors and talk about things other than COVID, QE, interest rates and inflation which have dominated all news flow of late. You only have to watch the news to realise just how consumed the media are by the COVID crisis and its impact on the well-being of the nation. The important thing to remember is that based on the experience last year, the Australian economy is very resilient and will bounce back. With the vaccination drive running at full steam, people as a community, will hopefully eradicate the disease and we can all go back to leading a normal life.
One thing is for sure though, central banks will tread very carefully moving forwards when it comes to economic policy. We are not quite walking on eggshells but near to it. In other words, whilst the central banks keep alluding to hiking interest rates, the reality is that the can will continue to be kicked down the road for the foreseeable future and low interest rates will prevail.
For a bit of fun, we take a step back in history and see just how far we have come in the world of fixed income. The origin of the term “coupon” is that bonds were historically issued in the form of bearer certificates. Physical possession of the certificate was deemed proof of ownership. Several coupons, one for each scheduled interest payment, were printed on the certificate. At the date the coupon was due, the owner would detach the coupon and present it for payment called “clipping the coupon”.
The certificate also contained a document called a “talon” which, when the original book of coupons had been used up, could be detached, and presented in an exchange for a block of further coupons.
Below is an example of a coupon with the face of President George Washington.