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'Hawkish in 2016': top investment experts react to Fed rate hike

'Hawkish in 2016': top investment experts react to Fed rate hike

In a much-awaited and well-telegraphed announcement, the US Federal Reserve increased its short-term interest rates for the first time since the 2008 financial crisis.

The 25bps hike brings the Fed Funds rate to a 0.25% to 0.5% range - seven years after it was cut to near-zero.

In the initial reaction, Asian markets opened higher this morning, a sign that the move was mostly priced in by investors.

While Janet Yellen once again reiterated her 'slow and gradual' approach towards hiking rates, the Fed's allusion to four more hikes next year is being perceived as hawkish by some.

Citywire Asia spoke to portfolio managers and private bank specialists on how investors should react to the rate hike, its impact on Asian markets and what to expect in 2016.

Andrew Swan, BlackRock

Head of Asian equities

The Fed has delivered exactly on expectations: A hike and the start of normalising monetary policy but with a dovish commentary. The well behaved nature of bond and equity markets overnight speaks to the Fed delivering on expectations for now.

The fact that Yellen expects a rise in inflation in the medium term could signal the start of weaker or at least stable dollar from here.

This would be positive for Asian markets given the constricting effect a stronger dollar has had on liquidity and central bank freedom in Asia. How these central banks react in coming weeks will be important to monitor.

A gentle rise in US rates has little impact on our portfolios and we think that gradual rate increases will lead to a period of normality for rates and growth in Asia.

There is however a risk that stronger US data leads to a more hawkish Fed in 2016 which could see more aggressive tightening and with that policy error in a low growth world. 

Richard Jerram, Bank of Singapore

Chief economist

The Fed unexpectedly made only marginal downward adjustments to its projections for interest rates over the next few years.

Our concern is that the markets are underestimating the potential for a sequence of rate hikes over the next couple of years.

This could give one final up-leg to USD as expectations adjust.

The immediate implications for Asian economies and markets do not appear too severe. Exchange rates have been weakening since the taper tantrum two-and-a-half years ago and equity markets have persistently under-performed.

Over the next couple of quarters we are likely to see two more rate hikes (March and June) and that should convince markets that the Fed is serious in its definition of 'gradual'. We could see some market volatility and USD strength as markets start to discount a more rapid pace of tightening.

Matthew Sutherland, Fidelity Worldwide Investment

Senior investment director for Asian equities

Asian emerging markets, generally speaking, have some good defensive qualities.

Aside from the fact that most are commodity importers, these qualities include current account surpluses, high foreign exchange reserves, low levels of foreign debt, and a recognition of the need for reform.

That background, and the fact that this rate hike has been so widely discussed and anticipated, makes it very unlikely there will be any significant adverse impact to Asian markets.

Hartmut Issel, UBS Wealth Management

Head equity & credit APAC, CIO

The Fed move was warranted and in line with our expectations.

The slight downward revisions to inflation forecasts and the 2017 hike expectations (dot plot) added a dovish tilt, although we continue to predict four rate hikes in 2016.

Both the US and the global economy should be able to cope with a gentle rate hike cycle, and this is positive for risky assets.

However, we believe that due to looser monetary policies and robust earnings growth the eurozone and Japan are likely to outperform the US.

On the FX front, we only expect minor USD strength versus the EUR and JPY as a large part of the hike cycle expectations have been priced in over recent quarters already.

Herve Lievore, HSBC Global Asset Management

Senior macro and investment strategist

We believe by beginning the hiking cycle the Fed is sending a clear message to the markets that they hold the upmost faith the recovery is self-sustaining and that inflation whilst mild now can be expected to edge higher going forward as was the case in September’s forecasts.

This policy change also reflects an anticipation of a gradual but continued pick up in wage inflation from a labour market close to full employment. Furthermore, it is clear that while the Fed will pay attention to international economic events it does not believe that they should be allowed to dominate the decision of when to begin to raise rates unless it posed a threat to the US growth outlook.

We anticipate the next hike will come in March 2016, with the Fed’s apparent intent of a 25bps increase every other meeting in 2016 well flagged by the dot plot, despite market expectations for a less aggressive path.

Given this move is in line with our expectations it does not result in a change in our asset allocation view, namely that we continue to favour risk assets relative to developed-market government bonds, in particular Asian Ex-Japan equities.

Joshua Crabb, Old Mutual GI

Head of Asian equities & managing director

We think the Fed’s rate hike is going to be a gradual journey. When we look at the reaction from markets, there was quite a lot of volatility in bonds and FX, however, most started and ended the day at the same point. One exception was equities, which ended the day better. Although volatility is likely to continue, this indicates what is reflected in prices of different asset classes with relation to Fed rate hikes.

This is the first Fed hike since it pushed the key rate to 5.25% in June 2006 and it shows that economies are finally resilient enough to make the Fed confident to hike rates again, bringing markets to a more normal environment. If rates are hiked more than expected it will likely be the result of either better growth potential and the possibility of a higher inflation. Of the asset classes, this will be more positive for equities.

The move won’t affect our portfolios dramatically, but it does take away some uncertainties and therefore increases our conviction.

Arthur Lau, PineBridge Investments

Co-head of EM fixed income and head of Asia ex-Japan fixed income

We don’t think the hike will have a material negative impact to Asian USD-denominated bonds, given the shorter duration profile.

Nevertheless, we think the credit cycle in the near term has peaked, mainly due to the moderating economic environment in the region coupled with continuing weak global demand.

As such, we expect credit spreads to widen somewhat in the near term, although we do not think overall the default rate will significantly increase.

At the moment, we expect the total return for investment grade bonds in 2016 will be around 1-2%, while high yield bonds will be 5-6% due to the effect of the carry.

For local currency bond markets, we believe there will be a bigger divergent due to the different stages of economic development in the region.

Kenneth Taubes, Pioneer Investments

Head of investment management, US

Our overall outlook for fixed income markets is fundamentally unchanged.

We have seen corporate credit spreads widen, which may represent a good opportunity.

While we remain cautious on energy, the recent sell-off in the high yield and bank loan markets has created select buying opportunities in many sectors. We believe bank loans offer particular value as floating rate, senior-secured assets.

Emerging markets have suffered in the wake of lower growth in China and lower commodities prices. Higher rates will hurt those countries with significant external USD-denominated debt. 

In emerging markets, we enter 2016 on a cautious note, as some economies are relatively more vulnerable to a Fed tightening. Based on our proprietary Vulnerability Index, Asia is the least vulnerable EM region, with China, India and Philippines showing the most resilience.

Mark McFarland, Coutts

Chief global economist

As far as the profile of interest-rate increases is concerned, it’s most likely that the trend will be shallow in 2016. Eurodollar futures put the implied interest rate at 1% for December 2016, and 1.5-1.75% one year later.

In terms of implications, there are four obvious ones. First, those with borrowings in US dollars or dollar-linked currencies can expect lending and deposit rates to increase by 0.25%.

This is unequivocally good for financial services equities, especially banks, but also insurance companies if interest rates go up more quickly than expected.

In loans sectors with high gearing, especially in the form of floating rates, caution should be exercised in exposure to over-lending.

Second, Fed commentary that it is comfortable with growth is better for growth stocks than high-dividend stocks if rates go up quickly ­– not the base case but one to consider.

Third, while the US government yield curve has shown little inclination to steepen so far, duration risk is still best offset by being aligned to corporate debt. You are being compensated nicely after the recent sell off.

Four, with rates rising, liquidity is likely to shift towards new bond issues, rather than existing ones where coupons are lower.  

Khiem Do, Barings

Investment director and head of Asian multi-asset

The Fed's Board of Directors rate projections were lowered, but remained much higher than those embedded in the prices of the two-year bond rates and Fed Fund futures.

Whether the bond market or the Fed Board will be correct in their predictions will depend on the strength of the US domestic economy, the growth of wages, and ultimately the inflation as reflected in the core above-mentioned PCE Deflator.

As it stands, we side with the market’s predictions, but we will be monitoring various partial inflation and growth indicators carefully.

In addition, given that the US economy has tended to be affected by weather and other seasonal factors in the first quarter of the year, it is quite possible that the next rate hike may not occur until April or June 2016.

If so, equity markets, including Asian equity markets, are likely to do well in the period leading to the new year and the first quarter.

Jim Leaviss, M&G Investments

Head of retail fixed interest

This increase in the key interest rate was expected, and in our view, was the appropriate decision.

In addition, with the drag of oil prices on headline inflation likely to diminish into 2016 and recent improvements in wage growth, the start of a normalization of monetary policy was in our view inevitable.

While somewhat balanced, we believe that the risks remain towards the upside and that the Fed may need to hike rates faster than markets currently expect.

That said, structural pressures on inflation and the high level of both private and government debt in many areas of the world mean that the terminal Fed funds rate (the rate at which the Fed will stop hiking in this cycle) is likely to be lower than it has been historically. 

John L. Bellows, Western Asset Management

Portfolio manager

The Fed did exactly what everyone expected and the markets were ready. The 25 basis point hike was already priced in.

Recent Federal Open Market Committee forecasts had four hikes in 2016, once per quarter. We expect they will hike at a somewhat slower pace, likely skipping at least one quarter.

The Fed does not want to be overly predictable, which Chairman Greenspan was criticised for in the 2004 cycle. The obvious way to deviate from a mechanical hiking path is to skip a quarter.

The March meeting is probably too early, but perhaps in June or September, when it will be more clear that growth and inflation are coming in under the Fed’s expectations.

Francis A. Scotland, Brandywine Global

Portfolio manager of global macro strategy

We acknowledge that the market anticipated the hike but we also believe the Fed should not have been in any rush to raise rates, as inflation expectations did not justify lift-off. Additionally, we think several potential pitfalls that could cause significant economic damage.

Collapsing commodity prices and rising credit spreads usually spurs the Fed to ease. The Fed has dismissed these developments, relating them to the shakeout in energy and temporary effects of a strong dollar.

To us they are important risk factors warning against a premature lift off. The business cycle is still not normal and profit growth is stagnant.

The risk is that the rate increase proves premature and subsequent hikes go too far, too fast.

Richard Skaggs, Loomis Sayles

Senior equity strategist

While stocks have generated meagre returns this year (S&P up less than 1% before dividends so far this year), the Fed's policy clarification will please company management teams who have been craving more clarity from the Fed as they make their business plans for 2016 and beyond.

We maintain a constructive outlook for stocks.  In other words, we don’t expect rates to move up so much that it would significantly alter or disrupt business decision-making. 

We will be looking to see if the wide performance differentials between sectors continues into 2016. While the first part of the year often sees laggards from the prior year bounce higher, it will be fundamentals that determine the sustainability of stock performance given the many fundamental crosscurrents.

Stock pickers who thrived in 2015 were those who had exposure to winning sectors like consumer goods, and were also able to identify survivors in poor performing sectors like energy and commodities. But let's be clear, this Fed move will do nothing to alter the tendency of stocks to bounce around as we enter 2016.

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