The Federal Reserve’s decision to hold interest rates last Thursday came as no real surprise as central banks often aim to keep monetary policy as loose as possible for as long as they can, according to Psigma’s Tom Becket. 
Along with the likes of Citigate’s Guy Dunham, Russell Investments’ Wouter Sturkenboom and Robeco’s Léon Cornelissen among others, the chief investment officer at the group believes that the Fed is likely to begin raising rates in December this year.
However, he adds that this is still only speculation and that global economic activity including the growth slowdown and subsequent market sell-off in China could lead Janet Yellen to restrain from tightening for the rest of the year.
“This subject is getting very boring, but it is of course important and the Fed will likely set the short and medium term path for markets, so it is worth thinking about this tedious subject further here today,” Becket said.
One of the reasons that he believes the Fed could boost rates before the year ends is that he thinks China will see an economic upswing before then, as some China specialists he has spoken to think that a combination of enhanced infrastructure and an improvement in the property market will provide a temporary boost.
What’s more, he adds that markets reacted badly to the Federal Reserve’s decision to hold rates, as many investors felt that steps needed to be taken as soon as possible to normalise monetary policy.
Indices including the S&P 500, the FTSE 100 and the MSCI World all closed on a loss the day after the announcement, and Becket believes that this suggests to the Fed that hiking rates could provide markets with a confidence boost.
Performance of indices over 1week
Source: FE Analytics
“Whether the Fed will raise or not in December is hard to judge, so we should stick to the fact that US monetary policy is likely to be looser than we had ever imagined and longer term rates are still being massaged lower by the Fed. This has big implications for asset markets and will help us to shape our strategy for the coming months,” he continued.
In terms of government bonds, treasury and gilt yields have dropped since the Federal Reserve’s announcement, and Becket says that they still look “uninspiring” over the medium term as they are still too expensive low and rates will inevitably rise.
In terms of corporate bonds, though, he believes that their excess yields compared to government bonds combined with low borrowing costs have made the asset class more attractive.
“Defaults are still rare,” he added. “Undoubtedly you want to be credit specific and not have too much duration, but the 'comfortable carry' trade of the last five years has been kept in place by Yellen and her cohorts. US high yield looks particularly attractive.”
Performance of sectors in 2015
Source: FE Analytics
In terms of equities, Becket thinks that the hold on rate rises could lead the European Central Bank and the Bank of Japan to take further action due to their short-term inflation goals seeming out of reach as their currencies strengthen against the dollar, and he says this is an added bonus as their corporate fundamentals also look strong generally.
Over in the US, he believes that equities are fairly valued, but warns that if the Federal Reserve is concerned about global growth then it might be prudent to follow suit and expect markets to remain challenging in the near future.
“I know I will get shouted at, but I am leaning towards the view that the rally since the August lows in the US and UK was the first of a 'bear market rallies' which faltered last week. This plays entirely into our 'sell the rallies' mentality,” Becket said.
Because he believes that rates may well rise this year and that Chinese growth could surprise to the upside, though, the CIO believes that the underperformance of emerging markets equities will actually begin to ease.
There are also some specific areas of emerging market equities that he thinks could deliver a strong outperformance at some point after markets begin to settle back down, although he admits it is difficult to imagine emerging markets rallying until the US market begins its road to recovery.
Another area of the market that has suffered this year is property REITs, which significantly underperformed the MSCI World index until it started to pick back up again earlier this month.
Performance of indices in 2015
Source: FE Analytics
Unlike emerging market equities, which he believes requires patience and a watchful eye, Becket has already begun buying into real estate investments trusts.
“Having held a cautious (and wrong) view of property assets over the last two years (despite using proxies to benefit from an improving backdrop), late last week we started to buy some property REITs, which have performed badly this year, but should be helped by the environment I have outlined,” he said.
“If the US yield curve is going to be held lower than we previously expected and the Fed will try and flatten it to keep long rates as low as possible, then the demand for income providing assets will remain.”
Over the longer term, Becket ultimately believes that inflation could surprise on the upside over the next decade due to loose policy actions from central banks, which would shock the unsuspecting investors.
“Holding cheap inflation break-evens and commodities might well have provided for sleepless nights in the last few years, but could well be the assets to help you sleep in the rest of the decade,” he explained.
“This will especially be the case if the Fed take even longer to complete the long and winding road to putting up rates. It’s been nine years; another month, quarter, year, decade won't hurt. Or will it?”