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Fed's more hawkish tone surprises bond managers

Fed's more hawkish tone surprises bond managers

While Janet Yellen and Co.’s move to hike interest rates was much anticipated, with market odds that it would happen topping 95% this week, managers were surprised by the Fed’s intention to raise rates three times next year.

The US Federal Reserve raised the range for its federal funds rate target by 25 basis points, from 0.5% to 0.75%, for the first time this year from the 0.25% and 0.5% previously.

Markets fell in reaction to the news with the Dow falling 120 points lower and the S&P 500 dropping about 0.8%. The dollar on the other hand has rallied.  

Citywire + rated global bond manager Jack McIntyre believes the Federal Open Market Committee (FOMC) was influenced by the uncertainty over how Donald Trump’s growth policies will impact the US economy.   

‘That’s why the markets are having the type of reaction they are, because there are a lot of unknowns. But what’s not unknown today is that the Fed is open to the idea of tightening three times in 2017 and that is a change of information from the two [they mapped out] in September,’ said McIntyre, a manager on the $25 billion Brandywine Global Opportunistic Fixed Income fund.

He added a caveat to this by saying that 12 months ago, after their first rate hike since 2008, the Fed had projected four rate hikes in 2016.

Western Asset's Julien Scholnick added this ‘surprise’ will see an increase in volatility across the sectors going forward, with risk assets especially getting hit.

‘Risk assets are having a difficult time digesting the news. If this is a Fed that is more aggressive than people are expecting then that’s a situation where they are going to be tightening financial conditions maybe more than people anticipated.

‘That’s clearly an environment that can be a bit challenging for risk assets, especially as it’s coming from an accommodative central bank.’

Veteran bond investor and Yellen-critic Bill Gross told CNBC in an interview following the announcement that he believes the rate rise will stall the rally in financials.

Financials have previously been tipped to gain from a rate hike as they have an increased flow of additional credit to up lending.

Gross said: ‘It halts the rally in financials and banks. Yes, banks like higher interest rates, but they like a spread between the long-term rate and the short-term rate and what we see now is the yield curve flattening from the upside with short-term rates going up. It narrows their [banks] margins and so financial rallies have been halted in my mind.’

Looking long

McIntyre said he would not be making any immediate changes to his portfolio but tipped long-term Treasury bonds to benefit.

He said: ‘If the Fed is really going to be hawkish, the long end of the Treasury curve is going to like that because that means that they’re [the Fed] not going to let inflation get out of hand and that inflation will drive the long end of the curve.’

Scholnick added: ‘If you get all this stimulus and meaningfully looser monetary policy than we’ve had for some time, then that clearly has some potential to be inflationary and with the unemployment rate at a really low level that would mean flattening of the yield curve.’

He also believes long Treasuries provide a good diversifier, especially if the optimism on US growth, which has seen fueling the market since the election, turns out to be a disappointment or if inflation does not rise as expected. 

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