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Investors think inflation is ‘just around the corner’: CIO

Anne Walsh, Guggenheim Investments' Fixed Income CIO joins Yahoo Finance Live to discuss how markets are faring amid pandemic and break down how more insurance companies should model their investment strategies.

Video Transcript

JULIE HYMAN: First of all, let's talk about that inflation debate and how it's affecting big fixed income investors. As I mentioned, we got that CPI data this morning, still showing inflation not happening. Jay Powell, the Fed chair, of course, is going to be speaking this afternoon and talking about employment, among other things.

Let's talk about all of this. Anne Walsh is with us now. She's the CIO of fixed income at Guggenheim investment. It's great to see you, Anne. Thank you very much for being with us.

As you look ahead to 2021, I'm curious where you guys come down on this inflation debate, how hot it could potentially get, how the Fed is going to react, and then how you're customizing your portfolios accordingly.

ANNE WALSH: Sure. Good morning. And thank you for having me on, Julie. You know, it's interesting. So the general consensus is that inflation is just around the corner. And the reason that investors think so is because there's been so much monetary stimulation that's been produced by the Fed and of course along with fiscal stimulus that's coming from Washington.

Interestingly enough though, money has to find its way into productive capacity before we find real inflation. We are instead however, finding monetary impacts in financial assets. And so that's really a significant difference between what we would call inflation in the traditional sense as measured by the CPI. And as we've already reported, CPI really hasn't started its progression upward.

Most investors think about inflation as a monetary phenomenon because of all this stimulus that's been injected. And by the way, I mean, unprecedented levels of monetary stimulus occurred in 2020, moving up the money supply as measured by M2 by almost 30%. That's a tremendous amount of monetary stimulus happening.

And so as a result, if you believe the words of Milton Friedman, who was basically the founder of monetary policy, inflation is always and forever a monetary phenomenon. However, he also said, subject to long and variable lags.

And so you ask the question, where are we in 2021. We don't anticipate seeing inflation moving up significantly in the traditional sense. Still a lot of disinflationary pressures out there. Technology is disinflationary. Debt is deflationary. But we do see all this money flowing into financial assets. And it's really giving a tailwind to the value of all sorts of assets, whether they be stocks-- of course, we're seeing that phenomenon-- or also bonds.

And as we talk further this morning, we can talk a bit more about what the difference is between the rates market as well as the difference between that and credit markets. So credit assets, who've got a huge tailwind behind them as a result of all of this--

MYLES UDLAND: You know, Anne, let's talk a little bit more about the role that monetary policy has played and could play in the future, and particularly as we get, essentially, all of the financial crisis accommodation shot into the market in-- what was that-- a couple of weeks, it felt like, back in March. And you're outlining we know it will matter. We just don't know when. What are maybe some early signs that you guys are focusing on or looking at as a sign that things have changed in the market and that investors are thinking differently about how the market is likely to absorb some of these impacts going forward?

ANNE WALSH: Sure. So you know, if you ask about monetary policy, the Fed has very clearly signaled that they are on hold until at least 2023. We take them at their word. And by hold, we mean they're going to continue monetary accommodation until at least then, and our view is likely longer.

Chairman Powell was quoted as saying that they have continuously under-predicted inflation for years, in fact, if not years, decades. And so as a result, what's different this time? And it's likely that we were going to continue to see this benign inflation number, again, as measured by the traditional measures of CPI and PPI for quite some time.

The Fed has also signaled that they're willing to overshoot their target of 2%. And let's remember what their dual mandate is, which is stable prices and stable employment. Well, we're not at full employment right now. And we have a long way to go until we get there. And certainly, coming into this coronavirus-driven cycle, we were at 3 and 1/2 percent unemployment. So we have a long way to go to get back to that.

And additionally, as long as we remain below 2% on the inflation target, the Fed has the ability and will continue to be very accommodative. And so we also have Janet Yellen as our new Treasury secretary. And she has also historically been very dovish. And the combination should lend itself to, again, continued monetary and fiscal support for the markets.

The amount of stimulus coming in from the Fed can be sort of discussed in two ways. One, certainly, they are continuing to be significant purchasers of Treasuries as well as agency mortgage securities. In fact, they're the largest purchaser of Treasuries right now. But also international investors are finding a good market here in the US, as around the globe, there's about $18 trillion of bonds trading at negative yields. If you consider that on an inflation-adjusted basis to be about real yields, that closes in on $30 trillion.

So investors all over the global are looking for yield. And they're still finding it in the US markets. So notwithstanding all of this accommodation, there's plenty of investment opportunity and drive and demand for investments, which is, again, also keeping yields low and the opportunity strong for investors in fixed income.

JULIE HYMAN: And I know in particular, Anne, that you Guggenheim's view is that risk assets continue to be attractive. Now, you work with a lot of big insurance companies, which, during different points in history, have had a little more risk appetite, sometimes to our detriment if you think about the financial crisis. But I'm curious what their risk appetite is now.

We talk a lot here on Yahoo about retail investors having a lot of risk appetite right now. How about with your insurance clients?

ANNE WALSH: So insurance clients as well as other members of what we might call the savings institutions, whether they be pension plans or long-term savers, are all still all together in the same place. They need to put money to work. And this is true in the US as well as internationally. We have a number of clients in the US as well as in Europe, for example, and in Asia. They're all part of the savings institutions industry.

And there's a huge drive to invest and the need to invest to meet their liabilities. This is especially true of life insurance companies. And the big elephant in the room for them is this continuing grind lower in yields, which makes their jobs harder to continue to meet those requirements and the spread requirements against their liabilities. But they are finding value. And we're working with them, of course, to find that value amongst the various different investment choices that are available in the broad world of fixed income, in particular.

And those opportunities are in what we refer to as the spread products, structured credit, corporate credit, and other assets away from what we would traditionally think of as the rates market. As you just showed a slide that demonstrates that right around 1.1 is where the 10-year Treasury is. And it's likely that the 10-year Treasury will retrace the steps down a little bit further.

At the same time, we're seeing spread price compression in credit sectors. So these investors are being challenged to continue to find yield in this particular time and in these markets. But they're certainly not alone. As I said, this is a worldwide situation that these institutions are finding themselves in.

BRIAN SOZZI: Anne, we've really seen investors of late plow into the junk bond market. Just given where corporate health is right now during the pandemic, do you like that move? Does that make sense to you? And is that the correct move?

ANNE WALSH: Well, so there's a really good question. For the first time, we've seen the high yield index, the Barclays US High Yield Index, go below 4% in yield. This is a huge move in yields that has occurred over the last year. And the CCC part of the index, which of course, is the riskiest part of the high yield market, is trading right around a 6% yield.

One could argue that CCCs aren't really compensating investors for risk. But what's interesting, if you think back to when Chairman Greenspan said that the markets exhibited irrational exuberance, these periods of heady price activity as we're seeing right now in these fund flows into the markets can continue for extended periods of time.

So while it may appear that you're not getting compensated on a nominal basis, the expectation is that these yields are going to continue to decline, and the spread compression is going to occur, again, for the really foreseeable future, next couple of years. In periods past when we've looked at this on a historical basis, credit spreads have been this tight on a relative basis as a percentile of Treasuries a handful of times in the past--


--in the late '90s, 2000s, leading up to the financial crisis as examples of when spreads can compress to these levels and on an extended basis. So again, our view is that while it may on a nominal basis appear very challenging to investors, we believe that these markets continue to have a tailwind and will continue to perform very well.

JULIE HYMAN: Very interesting stuff. So it looks like we're here for the foreseeable future. Anne Walsh, great to see you. Thank you so much for being here. CIO of fixed income at Guggenheim Investments. Be well, Anne. Thank you.