The end of the Federal Reserve’s interest rate hiking cycle could be approaching with a potential return to unconventional monetary policy on the cards, according to Jupiter Asset Management’s Ariel Bezalel.
Earlier this month the Federal Reserve announced it was raising its target range for the federal funds rate to 1.5-1.75 per cent as a result of higher inflation and lower unemployment expectations, highlighting the prospect for further rate hikes in the future.
“The committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” the Federal Open Market Committee (FOMC).
“However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
Indeed, the Federal Reserve’s dot plot – the mid-point of target range or target level for the Federal Funds rate – suggests that there could be further rate hikes this year, as shown below.
FOMC participants’ assessments of appropriate monetary policy
Source: Federal Reserve
However, Jupiter’s Bezalel said that while the market is currently pricing in four rate hikes by the Fed this year, he is only anticipating two or three.
The FE Alpha Manager said the outlook for inflation and growth would be greater driver of rates than supply of Treasuries, which has increased more recently.
“If you look from 1980 to today, yields fell from 15 per cent to 2 per cent despite there being a significant rise in the US government debt levels and the amount of US Treasuries being issued,” he said.
“So we are not concerned about the effect of greater supply on the US Treasury curve and think that any jitters in the market with regards to Treasury issuance are overdone.”
As noted at the recent FOMC meeting, policymakers are anticipating economic expansion to remain steady while inflation continues to tick up. 
“The economic outlook has strengthened in recent months,” the FOMC noted. “The committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labour market conditions will remain strong.
“Inflation on a 12-month basis is expected to move up in coming months and to stabilise around the committee's 2 per cent objective over the medium term.”
However, Bezalel (pictured), manager of the £3.9bn Jupiter Strategic Bond fund, is a bit less bullish about market conditions.
He said: “Ultimately our view remains cautious, we believe that the long end of the yield curve will compress lower to reflect lower growth and inflation expectations.
“That is based on our opinion that the market is in a late stage of the cycle and we are getting closer to the next recession.”
US quarterly real GDP growth since 2007
Source: St Louis Fed
He added: “We are seeing corporate leverage at record highs and the US consumer is under stress, with three consecutive month-on-month falls in retail sales and rising delinquencies on credit card debt and auto loans. Savings rates in the US have also plummeted to multi year lows.”
Bezalel said that whenever 10-year US Treasury yield gets close to 3 per cent, risk asset volatility increases significantly.
As such, the Federal Reserve, which has only raised rates four times since December 2016, may have less room to tighten than previously expected.
The manager, who is also Jupiter’s head of strategy – fixed income, explained: “So two or three rate rises could be the end of this hiking cycle, after which we could expect to see a return to unconventional policy measures as the US economy takes a step backwards over the next year or two.”
Indeed, Bezalel said he had slightly increased exposure to US Treasuries in his strategies and also increased duration – a measure of a bond’s interest rate risk – to around five years.
A large part of the Jupiter manager’s current US Treasuries exposure is located at the long-end of the year curve between 10-30 years.
However, Bezalel has taken a more cautious view on markets noting that “very stretched” valuations are prevalent.
The manager added: “US high yield in particular as a whole looks expensive to us and has been under pressure lately.
“However, there are naturally some parts of the fixed income universe where we are positive and our highly flexible strategy gives us the freedom to access them.”
One such example is emerging markets, where opportunities have been found in countries such as India and Russia.
“In developed markets, we are confident that the bull market in US Treasuries is intact and yields will head lower,” he explained. “There are also a number of high yield opportunities across Europe and the US we are excited about.”
Bezalel added: “Overall, we still expect that markets will be challenging and this will be a year for capital preservation rather than chasing returns.
“However, one has to remain attentive to take opportunities when valuations become attractive again.”
Performance of fund vs sector under Bezalel
Source: FE Analytics
Bezalel has managed Jupiter Strategic Bond since June 2008, during which time it has delivered a total return of 111 per cent, compared with a 35.1 per cent gain for the average IA Sterling Strategic Bond fund.
The fund has an ongoing charges figure (OCF) of 0.73 per cent and is yielding 3.5 per cent.