July 28, 2021
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Insights
How ESG considerations are reshaping central bank mandates
Andrew_Keirle_2_280x280px
Andrew Keirle
Ken_Orchard_280x280px
Kenneth Orchard
Quentin_Fitzsimmons_280x280px
Quentin Fitzsimmons
Ju_Yen_Tan_280x280px
Ju Yen Tan
Saurabh_Sud_280x280px
Saurabh Sud

Global Fixed Income Team

Each month, our portfolio managers, analysts, and traders conduct an in‑depth review of the full fixed income opportunity set. This article highlights a key theme discussed.

Moving toward integrating social and environmental issues.

KEY INSIGHTS

Building back greener, fairer, and more sustainable is not just the goal of governments and companies – central banks have also begun to incorporate issues such as employment equality and climate change into their policies. What we should expect from these developments, and their implications for bond markets and monetary policy, were the key discussion points during our latest investment policy meetings.

Central banks moving toward more flexible policy

Central banks are expanding beyond their traditional objectives of inflation and growth. The European Central Bank (ECB) and Bank of England have vowed to take greater account of climate change risks in their decision‑making, and some other developed market central banks have incorporated social considerations into their monetary policy frameworks. The Federal Reserve, for example, is focused on a “broad‑based and inclusive goal” of full employment, which means that the unemployment rate across the different sections of the population will be assessed when deciding on policy, not just the overall aggregate rate.

“We expect monetary policy to become more flexible as the objectives of developed market central banks evolve.”

“We expect monetary policy to become more flexible as the objectives of developed market central banks evolve to include targeting issues such as employment equality and climate change,” said Quentin Fitzsimmons, a portfolio manager and member of the fixed income investment team. It is likely to become harder to predict the actions of central banks going forward as more factors and data will now need to be taken into consideration, Mr. Fitzsimmons added.

There is also likely to be greater uncertainty around the path of inflation. “We recognize there is a potential risk that central banks do not react quickly enough to signs of price pressures rising under this new framework,” warned Mr. Fitzsimmons. For example, a central bank might ignore inflation overshooting if unemployment remained high in a particular group of society, Mr. Fitzsimmons noted.

Greater interest rate volatility on the horizon

These risks add to an already complicated picture around inflation. “The debate about whether the current spike in prices is transitory or structural in nature remains fierce,” said Mr. Fitzsimmons. He added that while inflation may have reached a peak, it may be more persistent and not fall as fast from these elevated levels as markets anticipate. This could drive developed government bond curves steeper again, but that is unlikely to happen until concerns around the coronavirus delta variant recede, Mr. Fitzsimmons said.

In general, then, the environment remains highly uncertain. “The delta variant may be front and center in bond markets right now, but there are inflation risks in the background – and these risks are magnified by uncertainty over future central bank actions due to the lack of clarity on how they are going to incorporate issues such as employment equality and climate change into policy,” said Mr. Fitzsimmons.

All of this suggests that there is likely to be greater volatility in fixed income markets on the horizon, a trend that we are already seeing signs of in 30‑year government bonds in select countries, including Germany, the UK, and the US Against this backdrop, we believe actively managing duration will be imperative going forward as greater flexibility will likely be needed in an environment of greater monetary policy uncertainty.

Potential bond‑buying programs are altered

To help meet goals such as tackling climate change, central banks could make changes to their bond‑buying programs. At present, bonds from all sectors that contribute to the economy are typically purchased. In the future, however, central banks may decide to give preference to bonds from companies that meet certain environmental, social, and governance (ESG) criteria. This would mean that some companies, such as those operating in heavy polluting sectors, could be left out of the purchases.

“There’s a risk of a two-tier corporate bond market developing if central banks start applying greater differentiation,” said Mr. Fitzsimmons. “Indeed, for those companies that don’t make the preferred buying list, liquidity could deteriorate, which might increase the credit premium required to borrow and perpetuate the problem further.”

“There’s a risk of a two-tier corporate bond market developing if central banks start applying greater differentiation.”

On the positive side, central banks are likely to play an active role in the green evolution. The prospect of bond and lending programs being altered to align with climate change goals is likely to influence companies to make changes as it should help facilitate their access to finance. These developments underscore the importance of having an ESG integration approach because it may help identify early the companies and the sectors that are making positive changes. It will also likely have a strong influence on how we assess valuations when looking at new bond issues that are brought to the primary market.

ID0004432 (07/2021)

202107-1730730

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Arif Husain is Head of International Fixed Income at T. Rowe Price. He is lead Portfolio Manager for the Dynamic Global Bond and Global Aggregate Bond Strategies. Mr. Husain is also Co-Portfolio Manager for the firm’s International Bond, and Institutional International Bond Strategies. He is a vice president of T. Rowe Price Group, Inc. and T. Rowe Price International Ltd.

Mr. Husain has 25 years of investment experience, eight of which have been with T. Rowe Price. Prior to joining the firm in 2013, he spent 14 years as director of both European Fixed Income and Euro Portfolio Management at AllianceBernstein. He was also a member of the global fixed income and absolute return portfolio management teams. Mr. Husain previously worked as assistant director of European Derivatives Trading at Greenwich NatWest and also traded interest rate swaps at Bank of America National Trust & Savings Association.

Mr. Husain received a B.Sc. (hons.) in banking and international finance from the City University, London Business School. He also has earned the Chartered Financial Analyst designation.

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This site is intended for Wholesale Clients. I have read the terms detailed below and confirm that I am a Wholesale Client and that I wish to proceed.

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Information contained in the T. Rowe Price website is not intended for investors in any jurisdiction in which distribution or purchase is not authorised, including the jurisdiction of the reader of this information, where applicable. For example, the information herein is not for distribution to and does not constitute an offer to sell or the solicitation of any offer to buy any securities in the United States of America to or for the benefit of United States persons. In certain jurisdictions, such as Australia, an investor must qualify as a wholesale client. Information contained in this website is not for retail investors. Information obtained from this site is intended specifically for the individuals who have agreed to these Terms and Conditions and may not be redistributed without prior consent from the T. Rowe Price Legal department.

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Persons who do not fall into the definition of wholesale client should not act upon the information contained herein.

This website is for general informational purposes only. This does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

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