2022 should herald the concluding phases of the end to ultra-loose monetary policies deployed by central banks since the onset of the pandemic. In the near term, the outlook for the end to quantitative easing relative to the policy rate path appears more certain, and the exit path shortening, with many advanced economies approaching full employment and above-target inflation and growth.
Relative differences in how central banks react to the forementioned data points, as well as market expectations for inflation and rates, suggest escape velocity will be uneven and volatile. The United States, in particular, has sharply pivoted to one of fighting inflation with the Federal Reserve expected to conclude its bond purchasing programme in early-2022 before embarking on relative interest rate normalisation. Even before concluding its rate hike cycle, the Federal Reserve is openly contemplating quantitative tightening (reducing the size of its balance sheet).
Locally, the outlook for short-term rates has also shifted sharply higher as markets started pricing for rate rises earlier than the Reserve Bank of Australia had indicated, with the central bank opting to discontinue its yield curve control program. Much will depend on the path for inflation, and just as importantly, its composition, with the central bank particularly focused on maximising employment and returning wage growth to above three per cent.
Although the backdrop for Australian households is favourable, we believe there are a number of reasons to suggest the central bank is unlikely to move as aggressively as markets are predicting, who are currently pricing up to three rate hikes in 2022. In particular, the prospect of softer wage and inflation relative to other developed markets should see the RBA proceed more progressively, in our view.
In theory, less easy money circulating should mean higher interest rates, but in reality, it is unlikely to be as straightforward. Longer-dated yields spiked in the early part of 2021 before subsequently flattening. The pandemic may or may not end in 2022, but unprecedented central bank support should. Yields have already moved higher in anticipation, pricing in the current rate hike cycle. The recent sell-off (higher yields) has been rather aggressive (although the shape of the curve is little changed), so yields are likely to grind higher before the long side appears with conviction.
With interest rate hikes priced in, greater value may be found in shorter-end, although we wouldn’t discount duration (particularly as 10-year yields approach their perceived terminal rate). A laddered portfolio can be useful in mitigating rising yield curves. The idea is to diversify and spread the risk along the interest rate curve to hedge against any idiosyncratic moves in rates, and average into intermediate- and longer-dated bonds as opportunities present themselves.
We believe other factors that have strengthened headline inflation in the Northern Hemisphere - particularly energy prices and rents - are likely to be less pronounced locally.
To read more about our interest rates outlook for 2022, you can download the full report here.