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When US monetary policy tightens: UBS CIO

When US monetary policy tightens: UBS CIO

UBS Wealth Management’s global CIO is recommending investors to put their money in hedge funds as defence against market downturns triggered by tight US monetary policy.

In his latest investment report, Mark Hafaele said that in the past 45 years each of the six recessions in the US were preceded by hiking cycles.

A downturn related to higher interest rates in the country, however, is not in UBS’ six-month house view.

‘While our base case is for only a gradual rise in US inflation and rates, the tightness of the US labour market means that a sharper rise in prices remains possible,’ he noted.

According to Hafaele hedge funds have historically outperformed other asset classes when monetary policy tightens, averaging 11.4% annualized returns versus 7.6% for the S&P 500 during the 1994–95, 1999–2000, and 2004–06 hiking cycles.

The Fed looks at two key indicators for setting the federal funds rate, which is currently at 1.25%-1.5%. 

‘While rapid inflation is not our base case, we will grow more concerned if: hourly earnings growth rises toward the 4% level seen ahead of the 2007 financial crisis; 5-year/5-year breakeven climb above 3% from 2.3% at present; the yield curve inverts, with 2-year Treasury yields surpassing the 10-year yield; or core personal consumption expenditure inflation breaches 2%, from 1.3% today,’ he explained.

Bond strategy

The executive also recommends long duration high grade bonds to protect against downturns.

He said although buying bonds to protect against inflation, and rising rates seems counterintuitive if the Fed is hiking rates to reduce inflation, long-term bonds could even rally on the expectation that growth might slow.

In line with the market, UBS has taken profit on its underweight position in two-year US Treasury notes. There has been a modest sell-off in US government debt in recent weeks following stronger-than-expected US economic data.

‘The market adjusted to our view that continued strong US economic data meant the Fed would need to hike rates more quickly than was being priced,’ Hafaele added.

Investors are also worried about the potential flattening of the yield curve as yields rise, which could lead to an inversion of the curve. An inversion typically signals a recession.

 Risk parity

According to Hafaele, risk parity strategies could be beneficial to investors as they hedge against inflation risks. These strategies aim for the same level of risk from different asset classes within a portfolio.

An inflation-risk cluster of commodities, precious metals, inflation-linked bonds and other asset classes could be a good defence.

He recommends regional diversification of portfolios with inflation in Asia, Europe and the US unlikely to rise at the same time.

UBS WM is currently overweight global equities and Eurozone stocks, excluding financials. It is underweight European high yield on expensive valuations.

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