The Federal Reserve can be considered customary
Head of Investment at Edmond de Rothschild AM
In its most recent meeting, the Fed's Open Market Committee maintained the ultra-expansionary monetary policy of the US central bank. And this despite the fact that the central bankers had only just revised their growth forecasts significantly upwards after a massive economic stimulus program had been passed by Congress. One thing is clear: only a minority of the committee members are in favor of tightening it in 2023. We take the fact that the Fed is still not saying anything about the conditions that could lead to tapering as an argument that liquidity is still at least at least high, despite a significant growth spurt will continue to increase for a few months.
How stable are the markets?
The Fed has quickly moved from trying to exert some control over the long end of the yield curve to loosening its grip. As a result, long-dated US bond yields have quickly returned to normal; the 10-year US Treasury yield has increased 80 basis points since early 2021. The big question is whether such a large move will destabilize the markets, especially since the indices look a bit fragile given current valuations. For now, however, we've essentially seen sector and factor rotation, with cyclicals and value stocks rallying sharply.
However, two points suggest that the US bond markets will now calm down again:
- Both the ECB and the Central Bank of Australia have demonstrated their determination to keep long-dated bond yields at current levels by increasing their purchases. This will widen the spread between the rest of the world and the US, making US bonds more attractive to investors and reducing the pressure on Treasury yields.
- Current yields in the US show that investors are already expecting three to four rate hikes by the end of 2023. However, should the Fed's scenario prove correct, there will be no political majority on the committee for even a single rate hike. In other words, the bond markets are anticipating moves that what the Fed has not supported.
Nevertheless, we do not want to rule out a further increase in the returns of US cross-country skiers, if only because bond markets tend to exaggerate. In addition, with the US economy emerging, we could also see erratic inflation data in the short term due to delays in supply and demand for certain goods and services.
The portfolios managed by Edmond de Rothschild Asset Management remain overweight equities. Because a further increase in long-term bond yields in the US is not a done deal, especially not at the rapid pace of recent times. A more gradual increase would be much more easily accepted by investors. And in any case, a market correction would not automatically be the result, even if interest rates continued to rise. In the past, stock market sell-offs occurred when investors began to factor in Fed rate hikes - which they won't this year - or when long-term inflation expectations seemed excessive, over 2.5 percent for the 10-year Inflation rate; at currently 2.3 percent, this is still a long way off. Therefore, the current surge in long-term bond yields does not appear to be associated with the usual effects that can affect all asset classes. What can return, however, is volatility. Because the S & P500 is currently strongly geared towards growth stocks with a long-term perspective. It is therefore naturally more sensitive to rising yields on long-term bonds.
Great Britain turned the tide of Brexit
It is precisely for this reason that we have reduced our exposure to US stocks in favor of UK stocks. The UK market's discount has widened since the Brexit referendum and the fact that it is biased towards value stocks makes it less rate sensitive. In addition, the vaccination campaign was a success and the country essentially turned the tide of Brexit.
In fixed income, we decided in January to underweight bonds - and we continue to believe that this is the case. We think it's too early to resume duration risk. In addition, when constructing a portfolio, we consider the possibility that long-dated bond yields will continue to rise, causing equity and bond risks to add up rather than cancel each other out.
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