Analysis: No relief for bruised markets as Fed signals higher rates for longer


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NEW YORK, Sept 22 (Reuters) – A Federal Reserve stall on fighting inflation leaves little hope that this year’s rocky markets will end soon, as policymakers signal interest rates are rising faster and higher than many investors expected.

The Fed hiked rates by an expected 75 basis points and signaled that its benchmark rate would rise 4.4% by year-end, to peak at 4.6% by the end of 2023, a steeper and longer trajectory than markets had priced in. Read more

Investors said the aggressive stance indicated more volatility in stocks and bonds in a year that has already seen bear markets in both asset classes, and risks that tighter monetary policy will plunge the US economy into recession. Continue reading

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“Regarding the Fed’s messages and the continuation of this program to hike rates to bring rates into a restrictive zone, the reality is setting in for markets,” said Brian Kennedy, portfolio manager at Loomis Sayles. “We believe we have yet to see the peak in yields as this is where the Fed will continue to move and the economy will continue to hold up.”

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Kennedy’s funds remain focused on short-dated Treasuries and hold “elevated” cash positions as he expects yields on both short- and longer-dated bonds to rise 50 to 100 basis points before peaking.

Stocks plummeted after the Fed meeting and the S&P 500 fell 1.7%. Bond yields, which move inversely with prices, soared, with the two-year yield climbing over 4% to its highest since 2007 and the 10-year yield hitting 3.640%, its highest since February 2011 the yield curve inverted even more, signaling an impending recession.

The S&P 500 is down 20% this year, while US Treasuries have had their worst year on record. These declines come as the Fed has already hiked rates by 300 basis points this year.

“Risker assets are likely to continue to struggle as investors become more cautious and somewhat more defensive,” said Eric Sterner, Apollon Wealth Management’s chief investment officer.

Rising US Treasury yields are likely to further dampen the appeal of equities, Sterner said.

“Some investors might look at the equity markets and say the risk isn’t worth it and they might shift their investments more to the fixed income side,” he said. “We may not see such strong returns in equity markets now that interest rates have normalized somewhat.”

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FED

In fact, the average price-to-earnings ratio for the S&P 500 was about 14 in 2007, the last time the Fed’s interest rate was 4.6%. That compares to an expected P/E ratio of just over 17 today, suggesting that if interest rates rise, shares must fall further.

“Powell is breaking the bank and remains very committed to fighting inflation and is not as concerned about the impact on the economy at this time,” said Anders Persson, Nuveen’s chief investment officer for global fixed income. “We have more volatility ahead of us and the market needs to adjust to that reality.”

“VERY CONSERVATIVE” THINK

Investors have accumulated assets like cash this year as they seek refuge from market volatility while also seeing an opportunity to buy bonds after the market slump. Continue reading

Many believe that high yields are likely to make these assets attractive to income investors in the coming months. The shape of the government bond yield curve, with short-term interest rates higher than longer-term rates, also suggests caution. The phenomenon known as the inverted yield curve predates previous recessions.

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“We’re essentially trying to establish where the curve is going,” said Charles Curry, managing director, senior portfolio manager of US Fixed Income at Xponance, who said his fund was “very conservative” thinking and owned more government bonds than the US over on.

Peter Baden, CIO of Genoa Asset Management and portfolio manager of the US Benchmark Series, a collection of US Treasury ETF products, said higher yields on the short end of the Treasury yield curve are attractive. At the same time, rising recession risks also made longer-dated bonds more attractive.

He compared Powell’s stance on inflation to that of former Fed Chairman Paul Volcker, who curbed higher consumer prices in the early 1980s by tightening monetary policy sharply.

“(Powells) says we will do what is necessary. You need to curb demand and bring supply back into line. This is her Paul Volcker moment,” he said.

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Reporting by Davide Barbuscia and David Randall; Additional reporting by Megan Davies and Chuck Mikolajczak; Writing by Ira Iosebashvili; Edited by Megan Davies and Sam Holmes

Our standards: The Thomson Reuters Trust Principles.



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