Analysis: The Fed indicates higher rates for longer, providing no respite to battered markets
NEW YORK A Federal Reserve dead-set on fighting inflation doesn’t offer much hopes that this year’s volatile markets will be over in the near future, as policymakers announce the rate will rise more quickly and faster than what many investors had hoped for.
The Fed raised rates by 75 basis points. It also signaled the policy rate will increase by 4.4 percent by year’s end and reach 4.6 percent at the end of 2023 which is a higher and more prolonged trajectory than markets had predicted.
Investors have said that the aggressive approach could lead to more volatility in bonds and stocks in a year which has seen bear markets for both asset classes and there are risks that tighter monetary policies will force in the U.S. economy into a recession.
“Reality is setting in for the markets as far as the messaging from the Fed and the continuation of this program to move rates higher to get rates into restrictive territory,” said Brian Kennedy, a portfolio manager at Loomis Sayles. “We don’t think we’ve seen the peak in yields yet given that the Fed will continue to move here and the economy is continuing to hold up.”
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Kennedy’s fund continues to concentrate exclusively on the short-term Treasuries and hold “elevated” levels of cash since he anticipates that the yields of shorter- and longer-dated bonds to increase between 50-100 basis points prior to peaking.
Stocks plummeted following the Fed’s meeting and an S&P 500 dropping 1.7 percent. The yields on bonds, which fluctuate in inverse relation to price increased, with the yield for two years climbing over 4%, the highest level since 2007 and the yields on 10-year bonds reaching 3.640%, the most since February 2011. The yield curve was to be even more inverted, an indication of a looming recession.
The S&P 500 is down by 20 percent in the past year, and U.S. Treasuries have had the worst year of their history. The declines have occurred because they are being weighed down by the Fed has already reduced the rate by 300 basis points in the past year.
“Riskier assets are probably going to continue to struggle as investors are going to hold back and be a bit more defensive,” said Eric Sterner, chief investment officer at Apollon Wealth Management.
The rising yields of U.S. government bonds are likely to be a drag on the appeal to stocks Sterner said.
“Some investors may look at the equity markets and say the risk is not worth it, and they may shift more of their investments on the fixed income side,” he added. “We might not see as strong returns in the equity markets going forward now that interest rates have been somewhat normalized.”
Indeed, the mean forward price-to-earnings ratio on the S&P 500 was 14.4 in the year 2007 which was the most recent time when the Fed rates were 4.6 percent. This compares to an average forward P/E of less than 17 in the present which suggests that stocks could be further down when rates increase.
“Powell is drawing a line in the sand and staying very committed to fighting inflation and is not as worried about spillover effects to the economy at this point,” said Anders Persson, chief investment officer for the global fixed income division at Nuveen. “We have more volatility ahead of us and the market will have to reset to that reality.”
THINKING ‘VERY CONSERVATIVELY’
Investors have piled up on assets like cash this year, as they seek some relief from market volatility as well as spotting opportunities to purchase bonds following the market slump.
Many believe that high yields will draw in investors who are looking for income in the future months. The design of the Treasury yield curve, in which the short-term rate is higher than the longer-term ones, is a sign of the need to be cautious as well. The term is used to describe the inverted curve this phenomenon has been seen in the past during recessions.
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“We’re trying to essentially determine where the curve is going,” said Charles Curry, managing director and senior portfolio manager of U.S. Fixed Income with Xponance and said that his company has been considering “very conservatively” and owns more Treasuries than it did in the past.
Peter Baden, CIO of Genoa Asset Management and Portfolio Manager of the US Benchmark Series the collection of U.S. Treasury ETF products The higher yields on the lower end of the Treasury yield curve are attractive. In the same vein rising risks of recession also increased the appeal of longer-dated bonds.
Powell’s position regarding inflation to the position of the former Fed chairman Paul Volcker, who tamed rising consumer prices in early 1980s through a drastic tightening of the monetary policy.
“(Powell’s) saying we will do what it takes. They need to put the brakes on demand and put that back in line with supply. This is their Paul Volcker moment,” he added.
