THE FED EFFECT: How does the Fed hike affect fixed income sectors?
Standish’s portfolio managers provide their thoughts on how the Fed’s decision to raise rates will affect the various types of fixed income assets they manage.
THE FED EFFECT:
how does the Fed hike affect fixed income sectors?
The time has come...
As was widely expected, the Federal Open Market Committee (FOMC) opted to raise the federal funds rate target range from 0.25% to 0.5% to
0.5% to 0.75%, only the second rate increase in the last 10 years. The FOMC now expects three rate hikes in 2017, two or three in 2018 and three
in 2019 and has upped its longer-run rate target from 2.9% to 3%. Here, Standish’s portfolio managers provide their thoughts on how the Fed’s
decision to raise rates will affect the various types of fixed income assets they manage.
EMERGING MARKETS
The Fed decision will
likely not have much
impact.
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GLOBAL
STRATEGIES
Duration diversification will
continue to pay dividends
while the Fed is one of the
few central banks engaged
in a hiking cycle.
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CASH/SHORT DURATION
The Fed’s comments and
projections for the medium term
will affect the market.
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INVESTMENT GRADE
CREDIT
Higher rates typically
generate additional
incremental demand
from yield sensitive
buyers.
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CORE BONDS
We expect little impact
on relative performance
in aggregate portfolios.
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u
US MUNICIPAL BONDS
Muni yields have overshot
Treasuries, reaching levels
seen only three other
times during the past 10
years.
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GLOBAL
STRATEGIES
We expect the theme of duration
diversification to continue to pay dividends
in a world where the FOMC is one of the
few global central banks engaged in a
hiking cycle and the US economy is most
primed for upsized surprises in economic
growth or inflation.
The recent bond market sell-off in
developed markets has been led by the US.
In particular, in shorter maturity bonds, US
rates have risen substantially, while many
other European and APAC markets have
remained more stable. We have also seen
lower correlation across countries with
respect to economic data.
Raman Srivastava, CFA
Deputy Chief Investment Officer
Given the Fed’s decision was already well
priced by the market, we do not believe
it will have much of an impact. Traditional
drivers for the asset class continue to
appear more supportive than they have
been during the past three years. Once
the level of uncertainty related to the new
Trump administration eases, we believe
these traditional drivers will reassert
themselves again and support a recovery
in emerging market debt (EMD).
Federico Garcia Zamora
Director of Emerging Markets
INVESTMENT
GRADE CREDIT
A gradual increase in interest rates is usually
supportive for the investment-grade (IG)
credit market. Typically, credit spreads have
a negative correlation with Treasury rates
because rising rate cycles usually signal
improving macroeconomic fundamentals
which are supportive of corporate earnings.
Higher rates also typically generate
additional incremental demand from yield-
sensitive buyers, like insurance companies
and pension plans. Furthermore, IG credit
bonds benefit from an additional cushion
against yield increases in the form of carry.
However, given that the hike is almost
completely priced into the market, we
would expect very little spread reaction to
this news.
David Morse, CFA
Director of Investment Grade Credit
EM
ERGING
MARKETS
t
u
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The theme of duration
diversification should
continue to pay dividends.
Traditional drivers for the asset
class continue to appear more
supportive than they have been.
Typically, credit spreads have
a negative correlation with
Treasury rates.
US
MUNICIPAL
BONDS
The muni market has
seen a technically driven
dislocation.
The potential for a rate hike was
already 100% priced into the
short duration market.
Muni yields have overshot Treasuries,
reaching levels seen only three other times
during the past ten years. This has been
a technically driven dislocation, with a
combination of record supply and mutual
fund redemptions overwhelming near-
term demand. The market has begun to
firm with buying interest from insurance
companies, investment managers and
crossover/overseas buyers. We expect
heightened levels of volatility amid
uncertainty regarding future US tax policy.
Christine Todd, CFA
Head of Tax Sensitive and
Insurance Strategies
The Fed decision did not have a material
impact on cash strategies. As usual, the
Fed has been communicating its intentions
clearly and the potential for a rate hike was
already 100% priced into the short duration
market. What will affect the market are the
Fed’s comments and projections for the
medium term, especially as they pertain to
any shift in policy bias for the remainder
of US Federal Reserve Chairwoman Janet
Yellen’s term. Technical factors, which are
always important around year end, will also
play a role, especially in light of money
market fund reform.
Stephan Bonte, CFA
Senior Portfolio Specialist
for Short Duration Strategies
SHORT
DURATION
STRATEGIES
US
CORE
BONDS
Our strategy has very little
tracking error risk versus the
benchmark.
We expect to see little impact on the
relative performance of US aggregate
portfolios from the hike in rates, unless
markets start to price in aggressive hikes
ahead. Our strategy has very little tracking
error risk versus the benchmark, except
for TIPs exposure. We will likely stay close
to the benchmark, but are positioned to
take advantage of any value created by any
volatility in the markets.
David Bowser, CFA
Managing Director of US Core Strategies
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[
important
disclosures]
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The comments provided herein are a general market overview and do not constitute investment advice, are not predictive of any future market performance, are not
provided as a sales or advertising communication, and do not represent an offer to sell or a solicitation of an offer to buy any security. Similarly, this information is not
intended to provide specific advice, recommendations or projected returns of any particular product of Standish Mellon Asset Management Company LLC (Standish). These
views are current as of the date of this communication and are subject to rapid change as economic and market conditions dictate. Though these views may be informed
by information from publicly available sources that we believe to be accurate, we can make no representation as to the accuracy of such sources nor the completeness of
such information. Please contact Standish for current information about our views of the economy and the markets. Portfolio composition is subject to change, and past
performance is no indication of future performance.
BNY Mellon is one of the world’s leading asset management organizations, encompassing BNY Mellon’s affiliated investment management firms, wealth management
services and global distribution companies. BNY Mellon is the corporate brand for The Bank of New York Mellon Corporation. Standish is a registered investment adviser and
BNY Mellon subsidiary. WPFEDPT121416
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