- Fixed Income Portfolio Manager
Skip to main content
- Funds
- Insights
- Capabilities
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
One of the discussion topics du jour is how the credit and equity markets might react to the US Federal Reserve (Fed) interest-rate hikes that are widely anticipated in the coming months. As is often the case with me, I find it helpful here to refer to past hiking regimes and market performances as a sort of guidepost.
To wit, I examined the historical returns of both US credit (for this purpose, proxied by corporate high-yield bonds) and US equities (represented by the S&P 500 Index) during the six months before the first rate increase of a Fed hiking cycle through the 12 months after said increase. The data demonstrate that both markets not only performed well heading into the first hike (although there’s some circularity because the Fed likely wouldn’t hike amid sharply falling markets), but also that both were able to sustain their positive performance for nine to 12 months after rate hikes commenced.
Specifically, we can evaluate US high-yield bond performance by looking at the market’s returns in excess of those of duration-matched US Treasuries during six cycles dating back to 1994. As shown in Figure 1, high-yield market results were generally strong leading up to the Fed’s first rate hike, but also remained positive after the onset of rate hikes. US equities sent an even more resounding message, outperforming for well over a year following the first rate hike.
My high-level conclusion from this analysis? In my view, it’s probably too early for investors to start positioning their portfolios defensively in preparation for a potential Fed-induced economic correction. As Alan Greenspan once famously said, “Monetary policy works with long and variable lags.” It typically takes a year or more after the Fed has raised short-term rates significantly for an economic contraction to set in and for risk assets (including both credit and equities) to respond in kind, sometimes by crashing. That’s precisely why the US yield curve has historically been such a great predictor of economic recessions and market returns.
Thus, I’d suggest waiting until short rates are at or above the level of the 10-year US Treasury yield rate before betting on a recession and positioning one’s portfolio to align with that view.
In a word, inflation. The above analysis covers a lengthy (roughly 30-year!) period of secularly declining inflation. By contrast, some of my colleagues currently expect global inflation to stay stubbornly above central bank targets over the medium term (with perhaps some moderation in the next few months). Might persistently high inflation cause central banks to behave differently this time around than they have in the past? Maybe.
To be clear, I don’t think most central banks will tighten monetary policy so aggressively as to risk pushing their economies into deep recession — like former Fed Chair Paul Volker did in 1981 to break the back of double digit inflation — but they may be inclined to accelerate the pace of tightening relative to previous rate-hiking cycles. This is something investors should keep a watchful eye on going forward. I know I will.
Chart in Focus: What does the rate cut mean for equities and bonds?
Continue readingChart in Focus: Four key areas of opportunities in bonds amid Fed uncertainty
Continue readingDisappearing unicorns: The importance of capital efficiency in a higher-for-longer rate environment
Continue readingURL References
Related Insights
Stay up to date with the latest market insights and our point of view.
What is “the economic cycle,” anyway?
See why the relationship between asset prices and the economic cycle is more complex than you might think, why a US recession is unlikely, and what a more dovish Fed could mean for the US and global markets.
Can central bank independence survive?
Can central bank independence survive? Macro Strategist John Butler discusses the challenges faced by central banks in an increasingly fraught political environment and how investors should adjust.
Chart in Focus: What does the rate cut mean for equities and bonds?
Are rate cuts positive? On the heels of the much-anticipated initial Fed cut, in this article we look to historic precedent for where the markets could go in the coming months.
The real issue on rate cuts? Keep your eyes on the dot (plot)
Keep your eyes on the Fed's 2025 dot plot. The real story is where policy rates are headed, not just the next rate cut.
Time to capitalise on the evolving role of bonds?
We outline why we think the new economic era is elevating the role of bonds as a source of attractive and stable income, downside protection and portfolio diversification.
Walking a mile in Fed Chair Powell’s shoes
A slow roll on rate cuts by the Fed could frustrate markets and lead to more volatility ahead of the September FOMC meeting. See our take on what to expect for the next few weeks.
Chart in Focus: Four key areas of opportunities in bonds amid Fed uncertainty
We discuss four key areas of opportunities in fixed income amid Fed uncertainty in the second half of the year.
Are US election probabilities now a critical driver of bond yields?
Our expert argues that the US election remains a critical catalyst for the bond market given the contrast between both parties as it relates to supply side policies such as trade and immigration, and to policy differences around taxation and regulation.
Disappearing unicorns: The importance of capital efficiency in a higher-for-longer rate environment
Members of our late-state growth equity team share their views on the impact of interest rates on venture capital activity — including the ability of companies to reach “unicorns” status.
Capitalizing on rate shifts: Parsing opportunities in the second half
Fixed Income Portfolio Manager Campe Goodman and Fixed Income Strategist Amar Reganti discuss how to capitalize on potential rate shifts in the second half of the year
Four questions for investors after Japan’s historic hike
With the Bank of Japan having finally moved out of negative rates, Macro Strategist John Butler identifies the four key questions he believes investors should focus on.
URL References
Related Insights
Learn why we believe FHLB loans provide compelling potential for insurers to add alpha or increase yield by borrowing at low rates and benefitting from possible favorable treatment by ratings agencies. In addition, explore examples of customized investment solutions that have the potential to capitalize on these advantages.
URL References
Related Insights
The real issue on rate cuts? Keep your eyes on the dot (plot)
Continue readingBy
Brij Khurana