While there is some debate about the exact meaning of the term “full employment”, a situation in which the number of jobs in an economy matches the number of adults capable of working is generally seen as desirable.
The downside to this situation is that it tends to lead to wage growth and inflation, which in turn leads to faster interest-rate hikes – cited as the biggest threat to the global bull run.
The market is currently pricing in three or four rate hikes a year from the Federal Reserve towards an end rate of 3.5 per cent. Jim Leaviss, head of retail fixed interest at M&G, said this is not unreasonable given all the signs of a tightening labour market – the latest of which relates to unemployed 30-year-old New Yorker Michael Rotondo, whose parents took him to court to evict him from their home where he had lived rent-free for eight years.
“Someone re-tweeted a story of [Rotondo] being offered a job as a pizza delivery person and said, ‘that’s it, we are at full employment’.
“There are some more robust measures of measuring this,” Leaviss added. “For instance, I saw yesterday that there are exactly 6 million unemployed people in the US and 6 million unfilled job vacancies. So effectively we have reached full employment.”
US civilian unemployment rate
Source: St Louis Federal Reserve
However, Leaviss is unconvinced that any resulting acceleration in rate hikes would pose a threat to the bull run, pointing out the transmission mechanism – the way that rate hikes feed through into the economy – is slower in the US than it is in other developed countries.
“In, say, Spain, mortgage rates are linked to Libor, while in the UK we are basically at variable rate or floating rate mortgages,” he explained.
“But in the States, if you are a corporate, you borrow for 30 years and if you are a householder, your mortgage is fixed off a long-dated bond as well. So rises in the Fed funds rate aren’t going to slow the US economy as dramatically as they would in the UK, Spain or other areas of the market.”
Leaviss (pictured) added that while rates will move higher from their current position, it is unlikely they will get back to their pre-financial crisis levels in the current cycle. That is not to say he doesn’t see a significant threat to the US economy – however, he said it is not one that will become a problem for another four years.
“As you are all aware, companies have done exactly the right thing, they have borrowed for 30 years, they don’t rely on a big refinancing wall in one or two years’ time,” he continued.
“There is a refinancing wall but it doesn’t come until 2022. We have had refinancing points before, but when we have had them, either companies have turned down dramatically or it has coincided with lower interest rates rather than significantly higher interest rates.
“So, you know it is hard to see where a slowdown caused by rate-hikes comes in the next year or two, but these things tend to be confidence-driven rather than anything else.”
The manager said there is a chance that the Fed may come under some political pressure – with US president Donald Trump hinting he wants to see the stock market “go up forever”, any wobble could see the rate-hiking cycle come under threat, and the Fed’s strength of independence is as yet untested in the current administration.
However, he was not concerned when current chairman Jerome Powell said forward guidance would have a much smaller role to play in the future.
“I think it’s hard to argue that forward guidance has had anything like the impact on global economies as QE or rate-hikes, it’s kind of the last tool in the toolbox,” he said.
“[Governor of the Bank of England] Mark Carney said that if we got down to 6 per cent unemployment in the UK, he would hike rates [the figure is currently at 4.1 per cent], so that was an example of forward guidance from the Bank of England, but it’s not that credible.
“And I don’t think it’s desirable either,” he added. “I strongly believe that central banks have power when they are surprising rather than when they are unsurprising.”
He said this is best illustrated by the anecdote from Mervyn King about the second goal Diego Maradona scored against England in the 1986 World Cup.
“Everyone remembers Maradona zigging and zagging through the England defenders, but Mervyn King pointed out that actually he just ran straight towards the goal and hit the ball in a straight line,” Leaviss continued.
“He said that’s what central banks should do – they should be like Maradona and use their eyebrows and shoulders to keep the market off guard.
“If you have a market that knows you are going to run straight to the goal – or that no one is going to hike interest rates – you end up with people loading up on credit and short volatility strategies.”
Leaviss added: “That’s why introducing elements of surprise, rather than exercising forward guidance – or perhaps being like Mark Carney, by hinting at forward guidance and then doing the opposite – is of more use to the global economy.
“It keeps that fragility in there which prevents the rise of risk parity and all these strategies that, when they unwind, are extremely painful for capital markets and financial stability.”
Performance of fund vs sector under Leaviss
Source: FE Analytics
The $2.1bn M&G Global Macro Bond fund has delivered a total return of 155.56 per cent since Leaviss joined in 1999, compared with a 115.41 per cent gain for the IA Global Bonds sector.
It is yielding 2.52 per cent and has an ongoing charges figure (OCF) of 0.81 per cent.