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Analisi 15.02.2019

The Fed returns the punchbowl to the party

The Fed returns the punchbowl to the party

Spotlight - The dramatic Fed pivot from hawkish in September 2018 to now at worst ‘neutral’ signals that the Fed is reluctant to ‘take away the punchbowl’ completely from the post-2008 economic expansion.


Key points

  • The Fed policy shift does little to improve the modest earnings growth outlook around the world in 2019. As a result, investors should expect single-digit returns absent new catalysts to earnings
  • Investors can now expect coupon-like returns in corporate credit instead of the ‘couponminus’ returns that characterised 2018
  • Brazil’s real, Turkey’s lira, and Russia’s ruble and Emerging Market debt should generally be beneficiaries of a renewed search for yield
  • A pivot to dividend strategies in equities combined with a focus on high-alpha strategies should benefit from a pause in Fed policy
  • Increasingly pro-active China policies improve the prospects for China, Brazil, and industrial commodity-linked equities as the Fed pauses

The Fed Returns the Punchbowl to the Party

In its January communication, the Fed provided a supportive tone for markets, remaining positive on the economic growth outlook, expecting stable inflation while at the same time pivoting its policy trajectory towards ‘patient’ and ‘flexible’.

The statement formally codifies the retreat from the hawkish tone the Fed Chair adopted as recently as September 2018, which precipitated the sharp declines in global markets throughout 4Q18.

Thus, while the Fed has spent most of 2017–18 gradually removing the proverbial punchbowl from the stock-market party by raising interest rates, its inaugural communication for 2019 suggests that Chairman Powell is not yet ready to fully remove the Fed’s support to the economy and markets. Instead, Chairman Powell has set the bar relatively high for additional rate increases.

Indeed, the timing of the Fed’s intervention is not coincidental in the context of its policy. Since 2012, levels of tightness in US financial conditions like those seen in 4Q18 have triggered similar Fed policy shifts. That said, the magnitude of the Fed’s recent pivot has been more dramatic than seen previously.

From a market perspective, a neutral Fed policy provides some comfort that the downside risk to US, and to a lesser extent, global earnings expectations should be contained, once they better account for the likely deceleration in growth in 2019.

Indeed, 2019 US earnings expectations have fallen sharply since early December 2018 where they sat at over 10%. By mid-January 2019, they had nearly halved to below 6%. Though some downside risk to these revised expectations remains likely, especially in Europe and parts of emerging markets, by late January markets appeared well on their way to re-pricing the more modest growth outlook.

Shift in Fed Policy = Shift in Investment Opportunity Sets

This more cautious stance of the Fed towards further tightening suggests a shift in opportunity set for investors.

Where fixed income investors had to face headwinds from the Fed rate hikes throughout 2018, resulting in ‘couponminus’ and negative returns overall for many bond investors, a pause in rate hikes should remove this headwind. With spreads wider, especially in the investment-grade segment, our multi-year caution in credit is no longer warranted.

Instead, with spreads near historical averages, investors can more comfortably expect coupon-like returns in the USD and EUR investment-grade credit segments. In the high-yield space, though spreads remain short of historical averages, even here our long-standing caution in the segment warrants a revisit. We see opportunities once again to begin building positions to benefit from the expanded carry especially against non-corporate carry strategies such as insurance linked strategies.

In addition, historically, a pause in the Fed’s rate-hiking cycle has meant that the ensuing flattening in the US yield curve will likewise pause and likely reverse. Looking back to the 1994–95 soft landing of the US economy, the pause in the Fed’s rate-hiking cycle resulted in the US yield curve steepening by almost 60 bps from a nearly flat 11 bps, just below the 16 bps currently.

Weak USD to Spur Carry Opportunities in EM FX and Debt

The pause in the Fed’s rate-hiking cycle will similarly bring a more durable end to the strong dollar regime seen through much of 2018. Interestingly, despite weakening domestic economies and political uncertainties in Europe, we expect the European Central Bank to face a stronger euro even as data deteriorates due to the limited policy options available. A weakening US-dollar environment should bring back the search for yield, with Brazil’s real, Turkey’s lira, and Russia’s ruble as the most attractive beneficiaries, we expect. As with high-yield, though spreads have rebounded smartly in January, investors should seek opportunities in emerging market USD debt as the impediments of 2018 – strong USD, high oil prices, and rising US interest rates – fade.

Read the Full Document with Charts

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Michaël Lok
Group Chief Investment Officer 
and Co-CEO Asset Management

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Norman Villamin
Chief Investment Officer Private Banking
and Head of Asset Allocation

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Patrice Gautry
Chief Economist

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Yves Cortellini
Deputy Head of Asset Allocation

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