Fund managers expect inflation to exceed targets for longer

Russell Investments polled fund managers in the US and found they are split on Fed inflation promise

Fund managers expect inflation to exceed targets for longer
Steve Randall

Inflation is considered one of the key risks to recovery as economies emerge from the pandemic.

A recent report shows that many Canadians are feeling the pressure of the rising cost of living with the Bank of Canada reporting inflation running above its 2%, adding the context of the pandemic driving down prices a year ago.

South of the border, the Fed’s take on inflation is also closely watched with fund managers now less confident that the US central bank will deliver its 2% inflation target.

A new survey from Russell Investments shows that 70% of fixed income managers expect inflation at above 2% for the next 12 months, almost double the share who thought this in the first quarter of 2021.

Around half of respondents to the second-quarter survey expect the Fed to deliver its inflation promise, down 10 percentage points from the previous quarter.

“Fixed income managers expect higher inflation to continue a little longer as the transition from lockdowns to full economic recovery accelerates,” said Adam Smears, Senior Director, Investment Research - Fixed Income at Russell Investments. “With higher inflation on their radar and the prospect for interest rate hikes moving forward, we expect managers will be digging deeper into asset classes in their hunt for yield.”

Why is US inflation running hot?

The poll follows a speech from Capital Group’s Pramod Atluri outlining why inflation is currently running hot in the US: Firstly, that we’re still lapping weak markets in 2020 and, secondly, that there are ongoing inflationary forces at work.

In his firm’s Mid-Year Outlook, Atluri said: “Higher inflation clearly has an impact on both interest rates and the yield curve but more important to my mind is that if it leads the Fed to tighten prematurely, it could also derail risky asset markets like equities and credit.”

Asset purchasing, interest rates

The Russell Investments survey found that 31% of fixed income managers expect the Fed to start tapering its asset purchase program as soon as the fourth quarter of 2021 although the first three months of 2022 is considered most likely.

Interest rates are expected to be on hold until 2023 according to 80% of fund managers and the same share expect between 2 and 4 hikes per year once the increases begin.

Asked about the bond yield curve, 43% of managers expect a bear steepening of the yield curve in the next 12 months – down from 71% in the first quarter survey – while 86% expect the 10-year U.S. Treasury yield to trade between 2.0% and 3.0% in the next 12 months, including 45% who pin it between 2.5% and 2.75%.