6 min read 21 Mar 23
This article first appeared in Citywire Selector in March 2023.
Inflation unlikely to see its tail end soon, says Ben Lord of M&G, but don’t let that turn you away from credit.
Though markets might be overestimating the extent to which inflation will see the end of day, M&G’s Ben Lord is not overly alarmed. In fact, the Citywire AA-rated manager is more bullish on credit than he has been in 15 years. Here he explains his reasons.
Ben Lord: Right now, we’re clearly in a disinflationary spot. That’s being led by a broad range of factors: base effects, commodities and the strong decline in money supply. So markets have started to price in a return to 2% inflation in the UK, US and Europe. But for me, it remains far too soon to commit to the idea that the 2% target level will return on any sustainable basis.
Ben Lord: One indicator is the strength of labour markets. It is dangerous to assume that inflation will fall back when we have the lowest-ever unemployment in Europe, 40-year lows in the US and a similar picture in the UK. If the labour market remains anything like as strong as it has done, it’s going to be very difficult to call the end of this inflationary cycle.
The other key point is that when recession hits in 2023 or perhaps 2024, will inflation be back in the box or will it remain elevated? If the former, central bankers would have scope to cut short-term rates to stimulate the economy. But if inflation is still around, that makes central bankers’ lives much more complicated because they might not have that scope to cut. I think that’s why the Fed has been in such a rush to push interest rates up, and why the ECB is now playing catchup so aggressively.
Ben Lord: Certainly there’s been an enormous move by bond and equity markets alike to try to front-run the return to on-target inflation. And in my opinion, it’s a bit too soon to do that. As I said earlier, another concern for me is that if recession hits and inflation isn’t where central banks want it to be, they might be unwilling to loosen policy. But there could well be millions unemployed across Europe, the US and the UK. So central banks would be under enormous social and political pressure to cut rates. And if they were to give in, again that would mean inflation staying elevated for longer.
Ben Lord: Yes. Right now, central banks have hiked aggressively and the bond market believes that we’re entering a significant slowdown or perhaps a recession. So the yield curve is deeply inverted. The question is, how will that curve evolve? If short rates get pushed higher and higher, while the market expects long term rates to fall due to lower growth and lower inflation, then it should continue to invert. But on the other hand, central banks could start to pivot.
Ben Lord: One a two- to three-year view, I haven’t been this bullish in 15 years. I think as things stand you want to have investment grade credit more than almost anything else – including equities. With UK investment grade credit you can achieve yields of 5%-6%. These are levels we haven’t seen since 2009.
Ben Lord: That’s also really interesting at the moment because for the first time since Covid, we’re starting to see central banks diverge. They’re moving in different directions at different times. That opens up a really interesting opportunity to generate performance for a global credit manager.
Ben Lord: The US has been very forceful in its interest rate hikes. As a result, everything except the labour market is pointing to a significant slowdown ahead. The consensus is that the Fed is nearer the end than the beginning of its rate hiking cycle. When it hits that peak in short-term rates, bond yields will fall as prices rise.
On the other hand, the ECB is still hiking really aggressively because it still has a core inflation problem and a very tight labour market. So a period where US fixed income yields might be falling and prices rising while the ECB is still hiking short-term rates to try to bring core inflation down, presents a really interesting opportunity for a manager to play the difference between those two markets.
Ben Lord: In recent years ESG investing has mostly been focused on exclusions. I think now what we want to do is move away from that screening and exclusion phase and start pushing for funds that are actually trying to find solutions to significant global social problems and companies that are trying to find solutions to significant environmental problems. That’s where I sense that we are moving as a business.
At the same time, we want to fund bonds that are labelled bonds: companies that are coming to market and issuing a green, sustainable or social bond where all of the money raised from the issuance will be put directly into projects, plants and equipment that will be dealing with the mega threats facing the planet.
I think M&G are well-placed to be involved in that area because you can’t just buy a green or sustainable bond, you have to have the analytical resource to dig in to where and how those proceeds are being spent, to cut through the greenwashing that undoubtedly goes on and to monitor the situation on an ongoing basis.
The value of the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. Past performance is not a guide to future performance.
The views expressed in this document should not be taken as a recommendation, advice or forecast.