To kick off Morningstar's Seeking Income Week, Schroders Chief Economist Keith Wade maps out the lay of the land for investors. While the oil price presents the greatest threat to the global economic recovery, Wade says, he believes that inflationary pressures in the emerging markets could be starting to ebb. But for investors in the developed markets, the slow speed at which central banks are likely to raise interest rates means that it will be at least another year of searching for income before interest rates once again surpass inflation levels. Opportunities for income remain in the equity markets and some bond markets, but until perhaps the back end of 2012 inflation remains a concern for income-focused investors.
Holly Cook: For Morningstar, I'm Holly Cook. Joining me today is Keith Wade. He's Chief Economist for Schroders.
Keith, thanks very much for joining me.
So the economic environment is very much in focus still, with various threats potentially to the globally economic recovery. What do you think are the most worrying threats?
Keith Wade: I would say at the moment, the biggest threat is probably the oil price still. What we've seen recently is the oil price has started to push up again. So it's now around about $120 a barrel from about $115. I still think that isn't enough to cause another recession in the world economy, but clearly if this trend continues then the squeeze on consumer incomes is going to slow down consumer spending growth, and that's the biggest part of the world economy and could lead to much slower growth. So I would say at the moment, the oil price is really the main threat.
Cook: What about central bank policy? The ECB is tightening monetary policy, and there’s speculation as to when the Bank of England is going to follow up with that. What is the impact of that on the investing environment as a whole?
Wade: Well, it's absolutely critical, and of course, one of the impacts from higher oil prices has often been that central banks have responded by raising interest rates, because they're worried about the inflationary effect of that. In this current cycle, it seems the ECB is very much in that camp, very much worried about second round effects from higher oil prices and has started to tighten policy. So that's a warning sign for investors.
Other central banks are behaving in a more relaxed fashion. They're looking through the rise in oil prices. They're recognising that the rise in oil prices also has effects on growth as well. So, the Bank of England and the Fed look as though they're going to look through this and raise rates later. We would expect the Bank of England to start raising rates in August this year and would expect the Fed to start raising rates in December this year. So really looking through the oil price effect, but the ECB is going alone on this one.
Cook: How about Bank of Japan? Obviously, there was a terrible disaster in Japan recently with the earthquake. How is Bank of Japan monetary policy going to impact the investing environment?
Wade: Well, the Bank of Japan is really pumping a lot of liquidity into the markets at the moment. Interest rates are already pretty close to zero, so there's not a lot more it can do. But it can certainly try to push down rates along the curve and it's been doing that quite effectively. It seems actually that's having quite a big effect on the yen, which has weakened sharply since the earthquake as the Bank of Japan has adopted this policy, and of course the G7 central banks have also been behind weakening the yen. And I think that’s also quite important for investors, because it means that the carry trade, which is a big important factor for driving risk trades in the world economy, that carry trade is coming back again.
Cook: So it still seems that the appetite for risk is starting to increase again perhaps and emerging markets were all the rage over the last few years, but that’s perhaps cooled off a bit and the focus has kind of come back to developed markets a bit. Is it fair to say that risk [appetite] is starting to pick up again?
Wade: I think it is, and part of it is because of that carry trade argument. The other side of it is that the developed market central banks are starting to raise rates; of course, the ECB, as we were just saying. There are some signs as well, that the inflationary pressures in the emerging markets may be beginning to ebb, but I think we are still a little way away from the point at which the central banks in the emerging markets can really signal the all clear. So, it looks as though the tide is beginning to flow back towards emerging markets at the moment, but we would still be a little bit cautious because we still think there is a bit of an inflationary problem there.
Cook: So inflation, obviously it's a long-term risk, but what about in the medium term? It seems we have a lot of discussion as to whether it’s really something that investors need to be worrying about at the moment, and obviously seeking out income is one of the main focal points for investors at the moment, something that they are struggling to do. How is the environment going to affect that going forward?
Wade: Well, certainly I do think that over the medium term inflation is going to be more of an issue and we think, for example, that the emerging markets are not going to play such a favourable role as they have in the past, and the other issue that worries investors is quantitative easing as well, a lot of money is being pumped into the U.S. economy—how are the Fed going to take that out without causing inflation? But from an investor perspective, the problem that people face is that interest rates are below inflation rates at the moment. So people are losing money on their cash.
Now, we are talking about interest rates beginning to go up, in the U.S., in the U.K., and the eurozone, those interest rate increases I think are going to come though quite slowly. So we are really looking at a situation where it won’t be until, say, the backend of 2012 that interest rates start to get up to levels in line with inflation. So, investors are still going to face this search for yield, they are still going to face the situation where their cash deposits are going to be yielding less than the inflation for at least another year or two. So, I think the search for yield is going to continue.
Cook: So perhaps a wait and see approach while preparing your portfolio for the eventualities over the next few years, would that be fair to say?
Wade: Yeah, I think investors need to be still looking for yield and I think they can still find it in equity markets or some of the bond markets. So, there are opportunities out there, and I think that’s really where investors have got to look at the moment.
Cook: Great. Well, thanks very much for sharing your insights with me today.
Wade: Thank you.
Cook: For Morningstar, I am Holly Cook. Thanks for watching.
