The long-awaited policy action by the Federal Reserve finally came to fruition last night, as Janet Yellen pulled the trigger on a 25bps increase following the FOMC’s December meeting.
While the move may have been anticipated by markets, what is the knock-on effect for bond investors over the near and longer-term? Citywire Global spoke to leading fixed income fund managers to find out.
Easing the pressure
Having spoken immediately after the announcement, Philip Barach, Citywire AA-rated co-founder of DoubleLine Capital, added that the move has given the Fed breathing room for the year ahead.
Let’s say they had raised rates in June, then I wouldn’t think they would have raised rates in December. They were committed to raising rates this year and they have done so.
We can talk about the subtleties of language and the potential for bubbles forming in parts of the market but they have stuck to their commitment. They almost got themselves into a box over the course of the year but that has now eased the pressure going into 2016.
Rely on relative value
Myles Bradshaw, head of global aggregate at French group Amundi, said the cautious approach in Fed language should be noted, as it aims to downplay a sudden surge in volatility.
What the Fed has done is try to make sure they don’t trigger any increase in volatility. We are not looking at a scenario like 1994 where we will see a sudden shift or increase in returns for the bond market. The way to approach this will be through relative value opportunities rather than through big bets.
The very front end of the US treasury curve looks expensive, as we don’t think they are pricing in risk, so we are underweight there, whereas there is still opportunity in Europe, as QE will support a lot of bonds in peripheral Europe.
The decision to approach further rises cautiously is important, according to Jim Leaviss, head of retail fixed interest at M&G Investments.
We welcome Janet Yellen’s words that the lift-off is not intended to be the beginning of a campaign to raise rates quickly, but rather that the Fed will remain flexible and that interest rates will rise only gradually, even though we think that in the end there is a risk that the central bank may need to hike interest rates faster than the markets currently expect.
That said, structural pressures on inflation and the high level of both private and government debt in many areas of the world mean that the rate at which the Fed will stop hiking in this cycle will be lower than it has been historically.
Determined to stay defensive
In a statement to Citywire Global, the Janus Capital fundamental fixed income team said the announcement would not shake their decidedly defensive stance, which they have held due to diverging monetary policy among central banks.
We recognize this rate hike raises the question of how will long-term rates be affected. We believe global deflationary pressures, including weak commodity prices, decelerating growth in key emerging markets, demographic trends and a strong U.S. dollar should keep long-term rates relatively contained.
As we have communicated for several quarters, our fixed income portfolios have been defensively positioned. We remain concerned about divergent monetary policies among advanced economies, stretched valuations across many fixed income sectors, nearing the end of the credit cycle, and low levels of market liquidity.
Security avoidance will continue to be a key driver in delivering risk-adjusted returns and capital preservation for clients. Importantly, we believe our defensive stance positions us to act as a provider of liquidity so that we can opportunistically step into dislocations and purchase attractively priced securities.
Constructive on credit
Janet Yellen’s remarks were designed to instil confidence and for Kairos’ Rocco Bove she achieved that. He now sees constructive opportunities emerging in credit markets.
The Fed raised rates in the right way: they’ve been sufficiently hawkish in a bid to not scare the markets and deter confidence. What the markets are expecting from the Fed, at the end of the day, is a message of control and confidence.
The Fed’s stance is dollar positive in my view: if last night I had a single bullet to shoot, I would buy dollars. That seems a little bit counterintuitive, because raising rates is normally depressing for markets. But if you raise it after 10 years it’s a signal of economic stabilization.
After all that, I would look to boost my dollar positions and stay long on credit. I am positive on credit, with a cautious stance on US high yield, where I see meltdowns as a bit more psychological at this moment of the cycle. Overall, I am bullish on European credit versus US high yield, also in the light of what we were saying about the dollar.
IG and HY could come good
Markets were satisfied two fold. Firstly that the committee believe the US economy is strong enough to move rates off the zero bound and secondly that they again reiterated how slow and gradual this rate hiking cycle will be when compared with previous cycles.
In this environment 10 year US treasury yields look fairly priced while opportunities exist in the high yield and investment grade corporate markets which have seen spreads widen to attractive levels over the course of this year.