Investors should prepare for a swift change in the bond market cycle as US rates finally rise on the back of strong US labour market figures for employment and wages growth, according to one of the world’s leading fixed income investors.
Jeffrey Rosenberg, chief investment strategist for Black Rock (pictured), said volatility would not be as dramatic as 2008, but that the new cycle would be more a “garden variety” change comparable to the bond market shifts that occurred in 1991, 1994, 1997 and 2002.
In anticipation of the change, he is urging investors to reserve liquidity in their fixed income portfolios, particularly at the short end of the curve.
Rosenberg, who visited Australia in the past week and spoke at the Conexus Financial Fiduciary Investors Symposium, sees the divergence as a key part of the new cycle with US rate rises contrasting depressed rates in the Eurozone.
In his most recent market outlook, he said: “With the surprisingly strong October U.S. payroll report putting a Fed hike in December even more firmly in market expectations and weakening inflation and growth in Europe putting ECB expansion of accommodation on track for December, the strengthening dollar reflects the return of ‘divergences’ in central bank policy as a dominant investment theme.”
His view that the cycle is changing is reinforced by the view that monetary reflation of the economy, at least in the US, has run its course.
“We are losing our confidence in the efficacy of monetary policy,” he said. “We cannot reflate economies anymore, it will have to be structural reform.”
Sue Wang, a principal at Mercer, was in agreement on many of Rosenberg’s points. “Central Banks have largely used their QE bullets,” she said. “While the ECB and BoJ will likely continue on the path of QE for some time, its effectiveness in dealing with crises has diminished.”
Her take on the shift in the bond market cycle was that there would not be a huge rise in spreads, as corporate balance sheets are in a much better position than in 2008. However, liquidity is now much worse and as a result investors are “cleaning up their credit books” to hold only “money good” names.
Wang was cautious on the pace of US rate rises. “It’s the path of rate rises and the ultimate terminal rate that matters. I think the Fed will be cautious (that is, hike slower rather than faster) until we see definitive wage growth, which has yet to emerge.”
George Lin, senior investment manager, Colonial First State, said markets have already factored in the idea of a rate hike cycle. “The first rate increase in December is largely priced in and probably would not generate a lot of reaction,” he said. “The big question is when we get into 2016 and say, after the second or third rate hike by the Federal Reserve, where will market expectations be? Past experience is that markets can underestimate the extent of the Fed’s rate increase or decrease.”
Lin added that a divergence between the US and the Eurozone is a widely accepted market consensus, with the US and UK probably the only two major central banks poised to increase policy rates in 2016. He said the big question for domestic investors is how far the interest rate differential between Australia and the US will shrink next year.
