Maintaining the courage of your convictions seems easier to read about in poetry (think of those mainstays of the Victorian era, “If” and “Invictus”) than to live with as an asset manager. We believe a simple narrative plays out within our investment horizon. We position accordingly, but we protect ourselves from being too wrong. The global economy continues to expand in 2018, with the growth of advanced economies mostly in sync and faster than that of their potential to produce. This puts pressure on costs and sends inflation higher, toward the inflation goals of two of the Big Three—the Bank of Japan and the European Central Bank (ECB)— and over that of the biggest—the Federal Reserve (Fed). We think an overachieving Fed tightens three more times this year and may talk into markets plans for higher rates. Even now, the median Fed official thinks that the policy rate will outstrip its long-run level— as do we, even more so.
We were at four hikes during 2018 for some time. Other financial market colleagues are moving to that view, as the chart shows, but are not there yet. This is not Gertrude Stein’s Oakland, there is a there there. Their journey to there gives Treasury yields room to rise, counseling a duration target short of benchmark, especially when considering that Treasury term premiums should rise as volatility increases when the Fed’s policy path is more contested and its security holdings shrink. Such an environment also put chips on what elicits the official response—rising breakeven inflation.