Tim Hext: Ukraine conflict offers glimpse into a world of stagflation

A weekly comment from Pendal’s head of government bond strategies, Tim Hext

WHEN it comes to bonds, some things are easy to read.

Strong data normally means inflation pressure which means yields sell off. And vice versa.

But events such as this week’s Ukraine crisis are less clear.

Do you jump on risk off and buy bonds? Or do you fret that already high inflation pressures are going to worsen, forcing central banks to tighten more?

This is a glimpse into the complicated world of stagflation.

Even career central bankers such as RBA governor Phil Lowe have only distant memories of stagflation.

Like most, he has largely operated for 30 years in a world of solid growth but low inflation.

Policy could be cautiously eased, unemployment falls and asset prices boom. Life is great for central bankers.

Hit the reverse button though and choices become very hard.

Now is such a time.

The US Fed needs to get financial conditions tighter in the US — they remain near all-time lows despite very high inflation, as you can see in the Goldman Sachs Financial Conditions Index below:

The Ukraine events may hit sentiment in Europe and even globally, but sanctions will push commodity prices even higher.

There is a left tail risk it worsens. But logic (and hope) suggest Putin’s aim is to install a Russia-friendly (or at worst neutral) buffer between him and NATO, rather than to expand further.

We think the US Fed may tip its hat to events by only going 25bp in March. But it will be a hawkish hike — that is, they need long-end yields to move higher to tighten conditions and rein in inflation.

This is especially so in an economy where mortgages are tied more to long-term, not short-term rates.

We saw such a thing from the RBNZ this week, which went out of its way to increase forward expectations despite only hiking 25bp not 50bp.

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This week’s events have not fundamentally changed our view that equities drift lower and bond yields higher over 2022.

After all that’s how you get tighter financial conditions.

What central banks want they can engineer — at least short term.

The 2021 halcyon days for asset markets are fading fast.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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