David Roberts

What the new Fed Chair means for bond markets

David Roberts

If we had doubts about new Federal Reserve Chairman Jerome Powell’s view of the US economy, we should have them no longer. By telling the House Committee that he felt the economy had strengthened in recent months, Powell signalled that the central bank is likely to raise rates by another 1% during 2018. So far, reaction has been muted with minor moves lower for bonds and equities.

Our view remains unchanged that US 10-year bonds are likely to move above 3% sooner rather than later. Equity markets are prepared for this. However, if policy is tightened more or at a faster pace than risk markets expect, it is unlikely we will break recent equity highs in the short term. Powell’s comments reinforce my view that the Fed is not currently concerned about financial market volatility.

Our core views on bond markets are:

  • Remain underweight outright interest rate risk but start adding in this area, especially in the US. Do not move “neutral” until we clear 3% for US 10-year bonds but even the current levels afford nice carry and protection.
  • The US is materially better value than other G7 markets with huge positive carry. If you need duration, take it in the US but offset this by shorting UK and core euro markets.
  • The curve: it is flattening again. We don’t think it has much further to go but Powell’s comments could benefit the long end. The easy money has been made, but for the brave (or mega bears), perhaps a little remains.
  • Investment grade credit: there is a low probability of default and it is easy to build a portfolio paying 4.5% in US dollar terms. It is too early to pile in, but as we near the end of the cycle, “locking in” returns at that level seems warranted.
  • High yield: I want another 50 basis points (around a 4-5% fall in prices from here) in yield. If equity volatility returns on a rate sell-off then this is highly achievable. Add to euro high yield.
Emerging market debt: how long is the barge pole? A small, expensive, illiquid asset class that hates a stronger dollar or higher US rates. What could go wrong?


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Thursday, March 1, 2018, 3:06 PM