Leaders from Generali Insurance Asset Management, Ostrum Asset Management and Allianz Global Investors discuss the looming recession at Fixed Income Leaders 2023
The likeliness of a recession was the topic of discussion in a thought-provoking panel discussion at FILS 2023. Amir Fergani, Head of Fixed Income France & EMEA at Generali Insurance Asset Management was joined by Philippe Waechter (Chief Economist at Ostrum Asset Management) and Stefan Hofrichter (Chief Economist at Allianz Global Investors) to discuss this, as well as the tough economic environment the UK and US find themselves in, and how China's reluctance to act as financier is impacting emerging markets.
Waechter began by stating his belief that a mild recession is coming to Europe in late 2023, which will affect Germany first. He also believes changes in the labour market will limit workers’ ability to negotiate higher wages, and that core inflation will lower in the coming months - e "a good thing for the European Central Bank". A recession in the US is less likely he said, but he added that internal political unrest is of some concern.
He also provided his thoughts on the status of risky assets such as credit assets, and its long-term implications. Waechter told the audience that investors expect stronger growth from the US compared with Europe, stating “We have a very proactive fiscal policy in the US", and that "we don't see this kind of situation in Europe." The Inflation Reduction Act, combined with its sizable investments has meant that the US has 'momentum dynamics' - something that Europe does not.
On the topic of emerging markets and how central bank policies in APAC in particular are affecting portfolio allocation, and the opportunities that exist in the field of fixed income, Waechter said that, thanks to the yield curve control, it is becoming complicated for Japan's central bank.
“Japanese rates will probably be higher in the future than they used to be and Japan will not be able to control the yield curve as they used to, even two or three years ago,”
Philippe Waechter
Fergani's thoughts on how emerging markets should tackle the problem is to employ diversification and points to some "attractive" local debt in regions such as Brazil and Indonesia.
“For insurance companies, such as European insurance companies, in terms of capital spend, it is quite punitive. So you need to have a decent pickup in terms of yield to be able to invest and to diversify the portfolios, but it makes sense to go into bonds.”
Amir Fergani
As the panel began to look to the future, Waechter told the crowd in attendance in Paris that he believes China's economy is still suffering and that it will not recover to be the economic power it once was. He said, "It will be very important on the political side, but the economy in China is really weak." With China unable to be the banker for these emerging markets, such as those in Africa, Waechter questioned their ability to fund development. Fergani claimed a key factor in this discussion impacting capital markets is the post-quantitative easing world we find ourselves in.
“Supply-demand dynamics is something to watch out for, because you need to finance deficits, and there are a lot of deficits in developed countries”
Amir Fergani
The panel then moved onto inflation and its route cause. Stefan Hofrichter concluded that the COVID pandemic and its resulting disruptions to the global supply chain, and the hike in energy prices because of Russia's invasion of Ukraine were the principal cause. The knock-on effects of the pandemic is causing a longer-term impact however, according to Hofrichter. The double-digit deficits in the US was primarily financed by central banks, who bought up sovereign bonds.
“That created a huge liquidity injection into the system, which then did not only stay in the banking sector, but was ultimately spread into a sharp increase in money growth, broad money growth.”
Stefan Hofrichter
That excess liquidity, according to Hofrichter, will mean a continuance of inflationary pressure until the end of next year at the earliest. Hofrichter outlined three 'Ds' that are driving higher rates in the long term – deglobalisation, demography, decarbonisation. A smaller part of the global decoupling of markets is former US president Donald Trump's trade wars and Brexit, according to Hofrichter. He also said the world’s population was getting older, and labour more scarce, adding: "This is a trend that has been going on for quite some time already, and explains why wage pressure is here structurally, not just for political reasons."
Rounding up his thoughts on inflation, Hofrichter told the audience he expects rates to be higher for some time, and that based on previous trends at the end of rate hike cycles, markets become too overpriced.
“We see currently a further rise in energy prices, lifting inflation, the Bank of Japan has barely started normalising its policy. All these are factors that could really still weigh on the bond market and bring bond yields up a little bit further.”
Stefan Hofrichter
He also expects a recession to be "very likely" in the US in H1 2024, and warned the industry to not downplay the financial stability risks. He finished off by highting the risks that exist within the nonbank sector of the financial services industry - namely the shadow banking sector and hedge funds.
“We know very little about the interconnectedness of these players with each other, but also with the banking system. So that’s a potential risk that we have to keep in mind.”
Stefan Hofrichter
These quotes were originally published by The Desk in an article written by Alex Pugh.