US may return to low rates after modest inflation

The rising inflationary risk in the US, fueled by strong recovery from the pandemic-induced slowdown, is likely to be short-lived and modest, and investors may need to brace for the return to a longer period of the lower growth environment, said new Asia head of New York Life Investments.    

Starting this year, a steady increase in global vaccination and policy support have contributed to the broad-based rise in consumer demand and corporate earnings, improving the economic backdrop for investing. A raft of upbeat economic data may send long-term bond yields higher in the near term.

But with the spread of the highly contagious Delta variant of COVID-19, policymakers remain committed to not derailing the economic recovery, said Jae Yoon, the US asset management firm’s chief investment officer. He was also appointed as chairman of its Asian operations in April of this year.

“Cyclical reflation has more room to run … We expect policy communication to remain clear and interest rates to remain low," he told The Korea Economic Daily in a recent interview following his appointment.

On the fiscal front, he said that US legislators are considering additional fiscal stimulus measures through infrastructure spending which, albeit smaller in impact relative to pandemic stimulus packages, are still important for extending the economic cycle.

With over $600 billion in assets under management as of the end of June, New York Life Investments is the asset management arm of New York Life Insurance Co.

“We are unlikely to face a permanently higher inflation and interest regime. At some point, investors will have to come to terms with a likely return to the lower growth environment,” he noted.

In addition, structural disinflationary forces such as demographics, globalization and technology should regain their dominance once pandemic-related disruptions fade. Supply constraints are already starting to ease, fiscal stimulus will soon fade, and pent-up demand is not open-ended.

"We expect (the US) inflation to remain above 3% through 2021, but to settle between 2% to 3% in 2022," Yoon said.

LOWER FOR LONGER FUTURE

He noted that the so-called “easy” part of the economic cycle, where broad-based gains across industries have raised risk asset prices, may now be over as the low base effects will likely fade into next year, and supply and demand imbalances are easing.

During the easy part of the cycle, lower costs of goods and recovering sales lifted operating margins and low interest rates elevated free cash flow as well.

Yoon advised that investors assess the impact of the recent surge in new COVID-19 cases on economic growth, inflation, interest rates and other drivers of asset class performance, adding that the health risk would contribute to a significant relapse for the global economy.

“Slower growth may also contribute to an extension of the lower for longer rate environment in many developed markets. … Substantial growth slowdowns could raise the prospect for further monetary and fiscal stimulus in some countries.”

Under the current investment environment, Yoon advised investors to be selective and stressed the importance of identifying company characteristics, such as pricing power, credit evaluation, and business model drivers. 

“A rising tide is no longer likely to raise all boats. Instead, investors may want to look closely at the investment strategies and even individual securities that can navigate these complex changes.”

FIXED-INCOME STRATEGIES

Regarding fixed-income sectors, investors need to balance the hot, volatile, near-term environment with a likely lower-return, long-term future, the CIO said.

In public markets, that means a tactical allocation to themes that benefit from an improving economic backdrop — value and cyclical sectors, infrastructure investments, and bond strategies that can leverage interest rate volatility and global opportunity.

In private markets, it is essential to work with seasoned managers who have experience across multiple cycles and can leverage multiple levers of value creation — operational expertise, pricing power, and deal access, he added.

Write to Yeonhee Kim at yhkim@hankyung.com