April 1st, 2022

When the Fed regains control

Advertising Material for professional investors only*

Investors familiar with Emerging Markets know that in a wage inflation spiral, the central bank must maintain a tight monetary policy by having real interest rates that are sufficiently positive (5Y inflation is a tad above the 5Y sovereign, see Graph below). This also helps avoid imported inflation from a weaker currency. Beyond this is unknown, as the Federal Reserve has no econometric model able to forecast the complex impact of a wage inflation spiral. To regain its credibility, the Fed must therefore 1. Aim for positive real interest rates 2. Avoid wasting time learning by doing 3. Regain control of the narrative which shapes our expectations.

1. Real interest rates need to be positive

The Federal Reserve needs to bring the terminal rate or long-term interest rates into positive territory as fast as possible. The reason is to avoid an uncontrolled spread of the wage inflation spiral, caution means overdoing it and we are not there yet. The cost of failing is a recession as real rates are brought to very high levels as Paul Volcker did in the early 1980s. With inflation at 7.9%, there is plenty of room for long-term interest rates to increase – though some of that inflation will naturally fade with improvements in the supply chain.

2. Avoid wasting time by learning by doing

It normally takes six to eighteen months for monetary policy to have an impact on the economy. With an economy running hot, it is likely to take longer. This is a very long time for the Fed to decide whether it wants to go ahead of the curve and not run behind inflation as some EM central banks do (e.g. Brazil). That is also a long period of time for investor expectation to have significant swings.

3. Controlling the narrative

In a system that is fundamentally unstable, we know that good control of the narrative can have a powerful effect by shaping the new equilibrium and inflation expectations. The Fed is already trying to wrestle this control from the market, but to become dominant, it will probably need to turn far more hawkish, something the White House may not be ready for ahead of the midterm elections.

What does it mean?

We remain prudent on US equities especially the Growth style, given potential shocks from liquidity being retrieved at a rate faster than expected. The equity market is likely too optimistic regarding growth prospects with the fixed income market more realistic. In fixed income, the opportunity set is wide with the potential for eventually a far more hawkish Fed.

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches and subsidiaries. This document is advertising material and is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest Key Investor Information Document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management AB recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. A summary of investor rights is available in English through the following link: https://www.nordea.lu/documents/engagement-policy/EP_eng_INT.pdf/. The Legal Entities’ branches and subsidiaries are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and subsidiaries. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and/or subsidiaries.

When the Fed regains control

Country selection

Disclaimer