ECM Asset Management’s Alex Temple sees opportunity in mixed messages from central banks
Alex Temple, portfolio manager at ECM Asset Management, an independently operated multi-asset credit investor owned by Wells Fargo, says that despite recent mixed messages from central banks, the Federal Reserve is unlikely to taper its QE programme before December.
The decision by the Federal Reserve to delay tapering of $85bn per month of Treasury and Mortgage Backed Security purchases, as well as the accompanying dovish rhetoric from chairman Bernanke in the press conference, caught investors by surprise. A decision to taper had been largely priced in by the market, so the barrier to commence tapering was extremely low and would have signalled an intention to address the ever increasing size of the Fed balance sheet, which is fast approaching $4trn.
However it seems that the Fed is still extremely focussed on incoming economic data and needs more signs of lasting improvement in the employment numbers before tapering. On this basis we feel that tapering has been postponed to December’s meeting (17th-18th) or even early in the 2014. Mr Bernanke’s term expires at the end of January with the ‘dove’ Janet Yellen now front-runner to replace him after Larry Summers pulled out of the race.
In this meeting, for the first time, the Fed published their economic projections for 2016 with their central tendency forecast (which excludes the three highest and three lowest projections) for unemployment in the 5.4% to 5.9% range and a Fed Funds target clustered around 2% for 2016. This has confused many Fed watchers as the “neutral rate” for the Fed Funds target is around 4% with an unemployment range of 5.3 to 5.8%. Bernanke explained this in the Q&A by arguing that the depth of the crisis has meant that the headwinds to recovery are so strong that the path to higher Fed Fund rates will take longer than it has in the past. The market has disagreed with the Fed on this point before but the September 2016 3m Libor future moved 40bps lower in yield following the meeting. We believe this is too strong a move and have positioned accordingly.
This is another symptom of the confusing messages created by current central bank forward guidance. Anyone who attempted to comprehend Mark Carney’s (in my mind an early Sean Connery look-alike, rather than Don Draper) explanation of the “knockouts” in forward guidance to the Treasury Select Committee the Thursday before last was left befuddled. It was no wonder that the Committee chairman, Andrew Tyrie, complained “It’s going to be pretty tough down The Dog and Duck working out whether this is a tightening or a loosening.”
So what does this mean for the markets? Equity and credit markets have rallied at the prospect of more quantitative easing and we see this trend continuing. Emerging markets rejoiced at a weaker dollar and gold rallied over 5%. US 10yr rates have settled around 12bps lower in yield at 2.75% and the 5yr is 16bps lower at 1.47% – the rally was driven by the 5yr part of the curve as traders re-entered carry positions. Given the delay to tapering and accommodating stance of the Fed, the US 10yr seems unlikely to challenge the 3% level, which it briefly broke through on the 6th September, in the near term. The willingness of the market to pay up for $49bn of Verizon bonds implies that it’s reasonably comfortable with duration around these levels. Consequently our Investment Strategy Group has adjusted its position on rates to neutral. In short we see the Indian Summer provided courtesy of the Fed as a second opportunity for investors to “fix the roof whilst the sun is shining” and move from the volatility of longer dated fixed income into the shelter of hedged credit.
You only live twice Mr Bond.