Though the Fed has been steadily tapering its quantitative easing programme this year, the consensus view is that the central bank will keep interest rates lower longer, providing support for fixed income assets.However McQuaker, and FE Alpha Manager and head of Henderson’s multi-asset fund range, says that the rapid pace of the US economic recovery will force Janet Yellen’s hand faster than first anticipated.
“The US is usually the key determinate for bond markets,” McQuaker (pictured) explained.
“The story so far this year is that the market was expected better economic growth but, due to issues surrounding inventory, bad weather and the impact of Obama-care, it disappointed.”
“However, data since then has been far more aligned with expectation and various indicators suggest that this type of economic performance has some legs. If you look at the confidence in smaller businesses sector, it is back to pre-crises levels as managements have stated their intentions to pay higher wages. Bank lending growth has also accelerated quickly.”
He added: “Put that together in as a package, the pressure is building on the Fed to change the way they talk about interest rates.”
Bonds markets have performed well so far this year, but McQuaker expects this to be a short-term phenomenon, forecasting capital losses and rising yields later on in the year.
Performance of indices in 2014
Source: FE Analytics
Though Mark Carney has already forewarned the market about his intentions to raise interests in the not-so-distant future, McQuaker says that if the Fed changes its tact, it would have much bigger implications.
“If these things come to pass, absent of any other shocks, that is a recipe for bond yields to rise,” he said.
“This applies to the UK as well of course, but the Bank of England has less resonance in bond markets. The BoE has already turned round and said that they may need to raise interest rates more quickly than we first expected. If the Fed were to say that, it would have a much bigger impact.”
Bond markets have reacted badly in the past when the Fed has spoken about its intentions to changed monetary policy.
The most recent example of that was last year’s taper tantrum, when Ben Bernanke warned that market in May that he would soon begin to taper QE. As the graph below shows, the prices of bonds plummeted.
Performance of indices in 2013
Source: FE Analytics
However equity markets, which have performed strongly over recent years on the back of the added stimulus, also sold off as investors moved to lock in profits.
When the Fed does eventually raise rates, McQuaker believes equities will also be adversely impacted.
There have already been signs of this with both the S&P 500 and the FTSE falling over the past week on the back of stronger than expected US economic data. The FTSE dipped below 6,540 earlier today – the lowest level it’s been since April.
“In the short term, it won’t be a good development for equity markets,” McQuaker said.
“However, after a period of time I think the equity market will find its feet again, but the bond market would be at a much lower level.”
McQuaker says this sell-off will therefore be similar to the one witnessed in 1994, when former Fed Chairman Alan Greenspan raised rates unexpectedly. According to FE Analytics, the S&P 500 lost 4 per cent that year while US treasuries fell more than 8 per cent.
Performance of indices in 1994
Source: FE Analytics
JOHCM’s Clive Beagles and Christopher Lees warned FE Trustnet about the possibility of a repeat of a 1994-style pan asset class correction last year. There are a number of experts who disagree with that view, however.
Anthony Doyle, investment director at M&G, told FE Trustnet earlier this week that investors should expect rates to remain low due to high levels of leverage in the financial system and on government balance sheets, structural deflationary forces and a “global savings glut”.
McQuaker believes that the Fed will start talking about raising rates in the next few months, either during the Jackson Hole Economic Symposium Conference or at the next FOHMC meetings. In anticipation of this, he says investors should prepare for a volatile end to the year for both of the major asset classes.
“Jackson Hole is coming up in September and that has been used by the Fed in the past to indicate policy changes. I don’t think you can ignore the chance that this time it could be used to implement an important policy change in the other direction,” he added.
McQuaker joined Henderson as head of multi-manager in 2005. According to FE Analytics, he has returned 65.13 per cent to his investors over that time, significantly outperforming his peer group composite, which has returned 34.71 per cent.
Performance of manager vs peers since July 2005
Source: FE Analytics
One of his best performing funds in recent years has been the £70m Henderson Multi-Manager Diversified fund, which has topped the IMA Mixed Investment 0%-35% sector over five years with returns of 55 per cent.
Given his views on the fixed income market, McQuaker and his team are very underweight bond funds. They have also been overhauling their equity allocations, selling down their exposure to small and mid-caps in favour of Richard Buxton’s Old Mutual UK Alpha fund and the £6.9bn Artemis Income fund, which are large-cap-focused.
