Expectation of a swift but deep recession has led Ken Orchard to buy his "longest‑ever duration position" in the form of a 10‑year US Treasury bond.
The portfolio manager of the T. Rowe Price Responsible Diversified Income bond fund said the speed of the growth slowdown over the past few months meant a recession was going to occur "sooner rather than later".
If correct, inflationary pressures should ease and the likelihood of big rate hike surprises in the near to medium term should reduce.
In a comment released on September 14, he said: "Sharp increases in yields tend to be episodic – they usually occur over a period of three to six months before the market stabilises again.
"The market priced in the peak in the Fed funds rate in June, and inflation expectations seem to have peaked for now.
"The Fed is very unlikely to have to hike more aggressively than is currently priced in – if anything, I suspect it may pause rate increases earlier than expected to determine whether the hikes it has already made have the desired impact.
"For these reasons, I currently hold my longest‑ever duration position in my portfolios."
He said he was focusing on long duration US Treasuries so far because the US was "further" in the hiking cycle than Europe. It will therefore likely finish sooner.
He added he was also looking at two‑year Treasuries, as the long end "has become more anchored following central bank hikes".
The yield on the US 10-year government bond was 3.43 per cent on September 14, while the two-year Treasury rose to 3.78 per cent after US CPI inflation hit 8.3 per cent for August.
This was down from its peak of 9.1 per cent in June but it was above what had been expected, leading Alastair George, chief investment strategist at Edison Group, to predict a further rise of 0.75 percentage points in September.
He said: "Fed chair Powell’s Jackson Hole speech called for forceful action to control inflation so the Fed now has to deliver. The sheer magnitude of the deviation of US inflation from target implies a long period of above-target inflation into 2024, even if survey-based inflation expectations are now moving lower."
Orchard said it was difficult to say whether the rate hikes already priced in would bring inflation under control or whether another round of tightening would be required.
"It is always hard to predict how sticky inflation will be. In the early 1980s, it took two rounds of aggressive hiking from the Fed – and a double‑dip recession – to bring inflation down to an acceptable level," he said.
"We do not know what it will take this time, but the prospect of unexpected hikes has receded for now – hence, our long duration position."
A deep but short recession
Orchard expects a "short but painful" recession, brought about by a "toxic cocktail of ingredients" including rapid monetary tightening, a weakened China due to its zero‑Covid policy, the war in Ukraine, an energy shock, and surging inflation.
"The market seems to have accepted that a recession is on its way, but there seems to be a widely held view it will not arrive until December at the earliest, and possibly not until well into 2023," he said.
"This is probably partly due to the strong US jobs market, and people just assuming the descent toward the next recession will follow historical precedent and be relatively leisurely."
But he said the jobs market was not a forward‑looking indicator, as he predicted any recession would "cut deeper than expected".
"The speed at which fundamentals have weakened this year have convinced me that this recession will come much quicker than we would usually expect," he said.
"Although household and corporate balance sheets are in good shape, meaning there are few imbalances in the economy, the number of headwinds the global economy still faces looks very ominous to me.
"There are further rate hikes to come, the war in Ukraine is rumbling on, China’s zero‑Covid policy is still in place, and the energy crisis has not been resolved. So, while I think the next recession may be short‑lived, I also think it may cut deeper than expected."
Earlier this month Schroders predicted the "worst year for global economy since 2009", as recessions were looming in the world's major economies.
It expects global growth to slow from 5.9 per cent to 2.6 per cent this year (revised down from 2.7 per cent) and to slow to 1.5 per cent in 2023 (previously 2.7 per cent).
Apart from during the height of the Covid-19 pandemic, this would be the worst year for the global economy since 2009, it said.
carmen.reichman@ft.com
