Merge by RHB | Rising yields a cause for inflation concern?

Bond yields have climbed in recent weeks, owing largely to mounting expectations of stronger economic growth and a higher inflation rate, particularly as pandemic fears subside.

We at RHB believe, however, that interest rates should be higher because we believe the market is overreacting and overly bullish on the recovery at the time of writing.

While most players in the market seem to be pricing in a V-shaped economic recovery, we are expecting a more volatile, W-shaped trajectory, with continuous ups and downs, as opposed to consistent improvements to the economy.

We base our opinion on the uneven distribution of Covid-19 vaccines and the challenges that countries are currently encountering while rolling out their respective vaccination programmes, with even developed markets facing delays amid various logistical difficulties. In this regard, we believe the overall vaccination rollout for many emerging market countries will be worse when taking into account access and infrastructure.

“This is why we believe significant challenges remain before global herd immunity can be achieved, which in turn suggests that a global economic recovery is far from complete, with the road ahead still highly uncertain,” says Tan Jee Toon, chief investment officer of Asia Pacific Equities at RHB Asset Management Pte Ltd Singapore.

How real is the fear on inflation?

In the circumstances, RHB believes the market may be overreacting to suggestions of inflationary pressure. While inflation could certainly become a concern further down the road, we do not see it as a problem for now. Having said that, we do expect to see higher Consumer Price Index (CPI) numbers in various countries over the coming months.

However, our rationale for the higher possible CPI data has more to do with inflation coming off historic lows, with some spikes in demand resulting in shortages of certain items, especially in view of supply chain difficulties. Even so, these issues are typically transient and will not be a cause for major concern.

In any event, given the significant unemployment in the economy, as well as the general underutilisation of industrial capacities, these are yet more reasons we at RHB are not so concerned about inflation in the short term. At the time of writing, overall industrial capacity is gaining momentum, but has yet to reach pre-Covid-19 levels.

Jerome Powell, chairman of the US Federal Reserve, has also downplayed inflation fears, pointing out that even if prices spike slightly this year, the rise would not be large or sustained, and that the two-decade trend of low inflation in the US is likely to continue.

How high is the bond yield?

While RHB Asset Management sees value at current levels, we remain cautious on the prospect of more sell-offs before the market stabilises.

The market tends to overshoot and we believe this will be one such instance. For now, we prefer to stay defensive by focusing more on the short-to-belly part of the curve, and look for opportunities to go long later.

How have rising bond yields affected fixed income and REITs?

Fixed income returns were negatively affected from rising bond yields. While credit spreads have tightened amid the economic recovery, it was able to offset only some of the negative impact from rising yields.

Real estate investment trusts (REITs) have also been laggards during the pandemic, as most human activity out in the world was heavily restricted during the multiple rounds of Covid-19-enforced lockdown. Naturally, this had an impact on the retail and hospitality REITs, among other REIT sectors. Having said that, data centre REITs remain relatively unaffected.

RHB believes REITs will have an opportunity to outperform the broader market, in tandem with national vaccination programmes. Retail and hospitality REITs are likely to recover once economies reopen, while potential mergers and acquisitions may provide further support to REIT growth.

It should be noted that, while REIT performance is still limited by rising bond yields, its distribution yields continue to remain attractive relative to bond yields.

How do rising yields affect equity markets?

As mentioned, RHB believes the market may be overreacting, as evidenced by rising bond yields over the prospects of a potentially straightforward economic recovery.

We also note, however, that the market is focused on inflation fears, as we have seen inflation expectations surging higher than pre-Covid-19 levels.

The market has even priced in central bank tightening as early as this year, and the possible reduction of liquidity in the system, putting stress on the valuation of equities.

So far, major central banks have reiterated their dovish stance on monetary policy. In addition, the recent earnings revisions for global companies have been positive, further supporting the recovery story.

Global manufacturing Purchasing Managers’ Index surged to 55 in March — its highest level since November 2010.

Our house view on fears of persistent volatility

Fears will persist, as suggested by the elevated volatility seen in both the fixed income market as measured by the Merrill Lynch Option Volatility Estimate index, as well as the equity market, as suggested by the widely used Volatility Index.

The recovery scenario has been uneven across the world and remains very much dependent on the outcome of the Covid-19 situation.

On top of the challenges posed by the vaccine rollout, new strains of the virus are being discovered, creating concerns over the efficacy of existing vaccines in dealing with these strains.

RHB believes these fears are likely to persist until global herd immunity is in sight.

Advice for investors

The key themes for 2021 are a focus on economic recovery as well as an improvement to global trade.

Cyclical sectors, such as consumer discretionary, materials, financials, energy and industrials are expected to benefit as the economy recovers. We would expect a rotation from defensives into cyclicals and the return of global funds to Asian markets in 2021.

Other than that, the global green movement, ongoing technological innovations, as well as global healthcare sectors are likely to benefit from supportive policies worldwide, with everyone from US President Joe Biden to Chinese President Xi Jinping expected to support these sectors.

The equity markets are expected to perform well, as corporate earnings will be upgraded amid ongoing economic recovery.

The low interest rate environment and ample liquidity will favour equities in 2021. Valuations may remain elevated, owing to a prolonged low interest rate environment and corporate earnings are still at the early stages of a rebound.

Investors should bear in mind that the recovery will be differentiated and uneven across the world.

As such, our advice is to remain invested and keep a diversified portfolio. What we can be certain of is this: There is always a silver lining to every outcome and there are always opportunities waiting to be discovered.

As such, investors would do well to stay calm and well informed, and to refrain from making rash decisions.

At RHB, our Relationship Managers and Investment Specialists stand ready to work with you to formulate an effective investment strategy to achieve your long-term investment objectives. Scan the QR code below to leave your details for us to address your concerns.

Invest with RHB Premier to unlock wealth opportunities.