the cost-of-living crisis, but this time around consumer balance sheets are in good health. You also hear about global debt levels. We have been wanting inflation for so long, but when we get it everyone panics. Strong nominal growth is good for yields rising because it improves debt-to-GDP.
Another issue is Europe. Italy and Greece in a good global growth environment should be more sustainable. The European Central Bank is attuned to supplying liquidity because they have had a lot of practice. The Fed is doing quantitative tightening but has set up its standing repo facilities. It is a case of: “We have taken liquidity away, so if you want some, come and ask us for it.” These measures are in place because policymakers have hiked rates in bad and uneven growth environments in the past. Now that we have synchronised growth and well-practiced policy- makers, terminal rates will ramp up because things are looking
better. It would not surprise me if terminal rates in the US were 3.5% soon. Lee: Another risk relevant to institutional investors is the inter- action between rates rising, inflation and equities. A lot of schemes are well hedged and have an LDI strategy, so the rate rising environment might be okay on a funding basis, but they will have to find the cash for any LDI collateral calls. Historically, moderate inflation is supportive of equity mar- kets, but persistent high inflation tends to bring equities down. Cashflow is a hidden risk if you receive collateral calls just as you need to find liquidity. Where best to find it? You are not going to sell your LDI assets, but you may have some illiquid credit or private debt. The other place to find it is equities.
Liquidity management is a risk one has always had to think about in the past, but now the possibility of it happening is more real and less theoretical.
16 April 2022 portfolio institutional roundtable: Fixed Income
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