Fed rates: She bangs the drum

Formed in Manchester in 1983, the Stone Roses were pioneers of the ‘Madchester’ movement of the ’80s and ’90s. For many students at the time, this music remains a defining part of their university experience. The group’s greatest hit “She bangs the drum” felt apt last week as – yet again – Mrs. Yellen decided to beat the drum, signalling that there would be two to three hikes this year.

This was different to the Fed’s previous beat, which had been decidedly dovish since the market volatility of January and February. But when she bangs the drum, that’s the beat the market marches to.

The political pressure on Yellen is immense from various actors in Congress looking to ‘audit the Fed’, a view supported by many of the candidates potentially running in November’s presidential elections (no one has officially received the nomination from either party). Given their academic backgrounds, it’s a limelight which Fed members probably won’t enjoy. The natural instinct is to keep their heads down and follow their mandate, especially in a US presidential election year. Yet the traditional mandate is now too narrow and the drum has been sounded on various international developments, which the Fed can’t but help take into consideration:

  • Standard & Poor’s reported another ten global corporate defaults, bringing the 2009 record well within touching distance.
  • Japan hosts the G7, while Prime Minister Abe is under increased domestic pressure.
  • The path of the US dollar and hence the renminbi is now the greatest immediate fear, as Chinese social and political arguments outweigh the financial side of any fallout.

The next Fed meeting on June 15 doesn’t give much ability to review global second quarter data, but if there are signs of an increase in global risk aversion, the Fed will bang the drum again.

Markets remain the epitome of the tightrope between fear and greed. Central bank suppressed volatility is now fighting against markets which are increasingly positioned one way, with ever decreasing exits and lacking the old buyers of last resort. The pain trade depends on the time horizon, but current positioning is to be long bonds and short stocks. That same positioning or consensus is long Trump, short Brexit and long France (to win Euro 2016).

Based on recent events, it’s only a matter of time before circumstances and events mean that we hear a new drum beat. With the number of macroeconomic, social and political variables on top of the skew in positioning and valuations, it’s a challenging market to navigate. However, there remains plenty of opportunities. For investors who have to march in step with a benchmark, it’s very easy to trip and stumble. It’s the investors with a truly flexible and unconstrained mandate who can dance to any beat.

 Jack Loudoun, senior portfolio manager at Vontobel Asset Management 
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