The EPFR Exchange Podcast

Episode 94: Central Banks walk different inflation tightropes

June 22, 2022 Kirsten Longbottom & Cameron Brandt Season 3 Episode 16
The EPFR Exchange Podcast
Episode 94: Central Banks walk different inflation tightropes
Show Notes Transcript

Kirsten and Cam discuss a week were the US Federal reserve raised interest rates by 75 basis points while the ECB, which is walking a different inflationary tightrope,  held an emergency meeting. Going into the third week of June flows for both Developed and Emerging Markets where anchored by the biggest single markets, US and China, respectively, while dividends and infrastructure remained beacons of hope for many investors. Join us to hear more on the investment landscape and the strong defensive flavor for sector fund flows with insight on Utilities, Financial and Technology Sector Funds. 

Kirsten Longbottom
Hello everyone and welcome to the EPFR Exchange Podcast, my name is Kirsten Longbottom and we are joined here today with Cameron Brandt, our in-house economist. We'll walk you through what the fund flows were doing last week and what we look forward to in the upcoming week. Cam, how you doing today?

Cameron Brandt
I'm doing well looking at a nice clear vista which I gather is not true in your neck of the woods.

Kirsten Longbottom
Yeah, not only are we kind of looking for that solstice day which means more daylight, more sunlight and more heat which not the best picture for Austin, but we also are having some dust storms. Dust and sand is picking up from Africa and now traveling to Austin or traveling to Texas and settling down. So interesting.

Cameron Brandt
Yeah, well, that's Texas's boast isn't it all roads lead to Texas?

Kirsten Longbottom
Exactly. So this week of the five big asset class groups: equity bond balance funds alternative and money market funds, we saw investors only interested in Equity while they collectively exited the other markets. Inflows for emerging markets were backed by China Equity bringing an end to their long outflow streak and US and Global Equity inflows help the overall headline number for developed markets. Want to give us highlights of the flows at the country and asset class levels?

Cameron Brandt
In a nutshell I think big is better. That the flows that we did see in both the Developed and the Emerging Markets equity space were clearly anchored to the biggest single market in both spaces. That would be the US in developed, China in Emerging with kind of a small commitment to Global Equity Funds which seem to be everyone's last giant saloon fund group over the past two years. The reasoning isn't that hard to follow both countries have big domestic markets that provide some insulation. The american consumer has yet to disappoint and China has a lot of policy ammunition that it can still fire and probably will given the imperitus of the Communist Party conference at the end of the year. Outside of those two big country groups, Dividend Equity Funds continue to appeal. That's a fairly classic response to inflationary concerns. And the sector fund groups have a pretty strong defensive flavor. Utilities which is another manifestation of the appetite for dividends. Utility Sector funds continue to do well. Infrastructure also maintaining its streak of above average inflows. Outside of that, it was sort of red ink pretty much as far as the eye can see though perhaps not as much as you might expect given the carnage we saw broadly in Global Asset Markets. I think we've already passed the point where for a lot of investors the question is whether to crystallize the recent losses or continue to go along for the ride in the hope that the moment the inflationary trends roll over the Fed and other major central banks will be quick to pull their foot off the brake.

Kirsten
So speaking of inflation, the Fed shifted to a more aggressive target for the latest policy meeting with a 75 basis points hike which is the most in a single meeting since 1994. But the latest inflation numbers still stand above 8% in the US and when I did a brief look at the yearly flows into Bond Funds, the year to date total for 2022 is on track to triple the record set in 2015. What were you seeing this week in that?

Cameron Brandt
I think though you know you can certainly argue the Fed is well behind the curve, it makes I think a lot of sense for them to front load their rate hikes. US consumers and corporations still have more than usual cash on hand between the money that consumers saved during the pandemic and the money that corporations were able to borrow at rock-bottom interest rates. That will only hold so long but there are some buffers in place to minimize some of the worst impacts of this more aggressive rate hikes. Even so in historic terms, it leaves interest rates at pretty low level especially given the inflationary backdrop. In terms of inflation, the problem we're facing at the moment is that there's a number of ways to combat inflation. One is to depress demand which is what the interest rate hikes are aimed to do but also you can increase supply. I mean if demand goes up, you can get more goods and services out there which will sort of start to bring prices down and that's where things are a bit different at the moment. Between supply chain issues, geopolitical tensions, you just can't whistle up extra supply in the way we had gotten used to in the previous two decades. So it is going to be a slower process but I still think that a lot of investors hope and expect that the Fed will go back to being what they call data driven as soon as it appears safe to do so.

Kirsten Longbottom
It seems it's a classic economics story just supply and demand. [But not as simple]. So on top of that Europe is seeing similar inflation levels around 8% and held an emergency meeting last week. What was that about?

Cameron Brandt
Well, that was about the the sort of thing that differentiates the European case from the US which is that raising interest rates to combat inflation puts stress on various patches and fault lines in the European project and the common currency, the Euro. The ECB had signaled that it was going to move fairly swiftly, especially for that body in recent years to shift interest rates within the eurozone back into positive territory. Albeit I think they're aiming plus 25 basis points by th end of the third quarter. But even that was enough to rattle markets which are used to the ECB basically sopping up the debt that other buyers aren't that interested in. We saw spreads between German and Italian 10-year Government Bonds begin to blow out much quicker than I'm sure the ECB was hoping. And this will remain an issue I mean the all central banks have to walk various tightropes. But in the case of the ECB the length of those tightropes and their variety really do pose a challenge. And then they have a major european land war going on to the East. The meeting I think was the ECB I think hoped that it would sort of signal that it's still ready to do what it takes but obviously the confirmation or denial of of market perceptions will come soon in the form of what happens to those spreads between German and peripheral debt.

Kirsten Longbottom
Interesting. So you mentioned at the beginning of the podcast, how a few sector funds saw outflows actually more than half of the sector fund groups reported outflows this last week. Was this in preparation for the upcoming corporate earnings season and did Adobe's outlook on the rest of the year which highlighted headwinds of summer seasonality, foreign exchange and of course the conflict in Europe influence where investors were putting or probably pulling out their money?

Cameron Brandt
So I think it's a little more nuanced than just positioning for the upcoming earning season though that will play a role. But to some degree I think more than has been the case in sort of recent earning seasons, investors have already made up their mind. I mean in the case of financials though rising interest rates are often seen as mildly positive because it gives them greater pricing power on the money they lend, I think a consensus has emerged that that isn't going to offset the problems caused by less credit-worthy borrowers finding it harder and the rising cost side on in terms of staff. Good people are hard to find and in many areas for business these days and keeping top talent in the financial sector is no different. You mentioned Adobe and in some ways I think that that is going to be the template for a lot of the earnings reports this quarter which will in the face of it being not that bad may even exceed expectations but will come with forward guidance that is less than cheerful. Technology Sector Funds are actually telling another interesting story which is that behind the headline numbers, we've seen a very sharp divergence between flows into technology sector funds dedicated to the US assets and the ones dedicated to China. Certainly during the second half of last year and into this year the heightened regulation and state involvement in key sectors was seen as a negative thing that compromised both China's stock market in the here and now and China's economic prospects well out. But in this much more hostile investment climate investors are suddenly a lot more comfortable with state interference, you know seeing I think as evidence of areas that the governments really care about and therefore that there are implicit guarantees of support should things go you know, really pear-shaped. Yesterday's interference with market forces is sort of today's kind of comfort blanket.

Kirsten Longbottom
Great, well thank you Cam and look forward to chatting with you next week.