23rd September 2015
Thomas Becket, chief investment officer at Psigma considers the decision by the Fed not to raise rates and its impact on five asset classes.
The Federal Reserve opted against their first rate hike in nine years on Thursday. It was no real surprise, we should have fully recognised that most central bankers now seem fully pre-conditioned to keep monetary policy as loose as possible, for as long as possible. Our view is that the Fed will now aim to raise rates in December, but we would add that this is mostly guesswork and point out that Fed Chair Yellen served up plenty of reasons on Thursday night why they might stand pat all year. I am fully aware that I am boring, but this subject is getting very boring. Here I go again…
But it is of course important and the Fed will likely set the short and medium term path for markets, so it is (probably) worth thinking about this tedious subject further here today.
The reason we feel that the Fed will achieve the necessary confidence levels to boost rates later this year is that China, Dr Yellen’s preeminent current concern, should start to see a cyclical economic upswing into the year end. This view was confirmed by two meetings with China specialists last week, who (sadly for them) shared our view that an amelioration in the property market and enhanced infrastructure spending will provide a timely, if temporary boost. A ‘wag’ in the office asked me on Friday if this meant that China was now in de facto control of US monetary policy; I replied that it was only fair given they own the whole of the US Treasury market.
A secondary, but still very important, factor is that the Fed will have seen the negative impact upon asset markets that their decision brought last week and recognise, as we suggested, that putting rates up could actually be a positive confidence boost.
Whether the Fed do go or not in December is hard to judge, so we should stick to the fact that US monetary policy is likely to be looser than we had ever imagined and longer term rates are still being massaged lower by the Fed. This has big implications for asset markets and will help us to shape our strategy for the coming months. Here are the key features:
Bonds – Treasury and Gilt yields have come down since the decision and still look uninspiring from a medium term prognosis. There might well be rallies in yields, but ultimately rates will go up and the whole sovereign debt curve is too low.
Credit – The lack of an interest rate cut continues to make credit instruments very active; excess yields over government bonds are attractive (spreads), borrowing costs are low and defaults still rare. Undoubtedly you want to be credit specific and not have too much duration, but the ‘comfortable carry’ trade of the last five years has been kept in place by Yellen and her cohorts. US high yield looks particularly attractive.
Equities – The lack of action from the Fed could well trigger further action from the Bank of Japan and European Central Bank, where they are seeing their currencies strengthen against the dollar and their short term inflation goals unachievable. Moreover, corporate fundamentals in those markets look sound. US equities still look ‘fair value’ to us, although some opportunities remain. If the Fed is still very worried about global growth then we have to recognise that it might well be a challenging environment ahead for stocks across the world. I know I will get shouted at, but I am leaning towards the view that the rally since the August lows in the US and UK was the first of a ‘bear market rallies’ which faltered last week. This plays entirely into our ‘sell the rallies’ mentality.
Emerging Market Assets – The major negative factors for EM assets this year have been the threat of tighter US monetary policy and the slowdown in Chinese growth. Given all comments previously made here today, the reasons why EM equities have underperformed should start to ease and when markets settle down, we would expect a period of strong outperformance from certain EM equity and debt markets. In the short term it is hard to imagine EM equities rallying, unless the omnipotent US market starts to improve.
Property – If the US yield curve is going to be held lower than we previously expected and the Fed will try and flatten it to keep long rates as low as possible, then the demand for income providing assets will remain. Having held a cautious (and wrong) view of property assets over the last two years (despite using proxies to benefit from an improving backdrop), late last week we started to buy some property REITs, which have performed badly this year, but should be helped by the environment I have outlined.
Finally, and this view is longer term, I remain fully of the view that uncertainty over inflation later this decade could well surprise on the upside, aided by the insanely loose policy actions of central bankers, delivering a materially nasty shock to complacent investors. Holding cheap inflation breakevens and commodities might well have provided for sleepless nights in the last few years, but could well be the assets to help you sleep in the rest of the decade. This will especially be the case if the Fed take even longer to complete the long and winding road to putting up rates. It’s been nine years; another month, quarter, year, decade won’t hurt. Or will it?