Federal Open Market Committee (FOMC) on 26th and 27th this week expects another big rate hike, threatening to rekindle market turmoil, making bond investors a risky investment I'm ready to protect myself.
The FOMC, which shocked the market by raising interest rates by 75 basis points (bp) at the previous meeting, is strongly expected to raise interest rates by the same amount this time as well. However, the whereabouts of the subsequent meetings is unclear. Just a week ago, the market factored in a 1 percentage point hike this month.
In this nervous environment, many portfolio managers remain "risk-neutral" or have short durations and are choosing high-rated stocks in the corporate bond market.
The longer the duration, the greater the loss if interest rates rise.
"Many companies are trying to strengthen their defenses and protect themselves from the effects of the FOMC's monetary tightening and uncertain inflation trends," said Rob Daily, bond director at Glenmeed Investment Management.
Recently, the consumer price index (CPI) reached its highest growth rate in 40 years in June, and the market has factored in a 100bp rate hike, and two FOMC hawkish executives said they would support a 75bp rate hike. There was also a scene where I went to extinguish the fire.
In the “swaption” market, which is an option for interest rate swaps, the volatility of maturities, which are sensitive to the movement of policy interest rates, has jumped to the highest level since at least February 2013, indicating the strength of caution among bond investors. ..
Glenmead's Daily has gradually reduced his portfolio's risk tolerance over the past few months and is now "neutral" in duration. "I think the market is underestimating how much the FOMC can raise rates," he said.
If the FOMC raises interest rates by 75bp this time, the federal funds rate guidance target will be 2.25-2.5%. Looking at the Fed Funds rate futures market as of 22nd, the market is incorporating an additional 180bp rate hike by the end of the year. It is assumed that there will be a 60% chance of a 50bp rate hike in September.
The FOMC has raised rates by a cumulative total of 150bp since the beginning of the year.
But the Eurodollar futures market has begun to factor in the FOMC turning to rate cuts in the first quarter of next year in recent weeks.
Of course, not all bond market participants feel the need for a defensive investment strategy. Yields have already peaked, ING Americas executive Padrik Garby believes, "an opportunity to prolong the duration and return some liquidity to bonds."
Garvey cites the decline in long-term inflation expectations. The FOMC may have room to suspend significant rate hikes in the future.
The break-even inflation rate of US Treasuries, which indicates the expected inflation rate of the bond market, has been declining for the entire maturity of 1 to 30 years.
"My current view is that the 5-year yield peaked at 3.6% and the 10-year yield peaked at 3.5%. In our view, this is the FOMC's ultimate goal. Let's explain. " If the FOMC raises interest rates by 75bp this month, it will "finish more than two-thirds of the required rate hikes and start moving towards withdrawal."
Meanwhile, Tony Rodriguez, head of fixed income strategy at asset management firm Navine, remains in a position to prepare for rising volatility.
Navine also incorporates into his portfolio the possibility that the United States will probably enter a recession next year.
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