Background
The US Federal Reserve (Fed) concluded its June two-day meeting on Wednesday (16 June) and the Federal Open Market Committee (FOMC) kept the benchmark rate at c. zero as was broadly expected. Similarly, the Fed’s 2021 inflation forecasts crept a little higher (in line with expectations), albeit not meaningfully so. However, most market participants were caught off guard by the Fed signalling that there could be two rate hikes in 2023. The main surprises for us were that the Fed seemed to have pulled the expectation of its first rate hike forward from early 2024 to 3Q23 in its dot plot estimates of future rates. At the post-meeting press conference, Fed Chair Jerome Powell indicated that initial discussions around when the Fed should talk about tapering bond purchases have now started.
What does this all mean?
We find it telling that the inflation forecasts have not risen meaningfully. Instead, the Fed continues to hold the view that the US inflation we are currently seeing is being driven by supply bottlenecks and the global unlock post the COVID-19-induced lockdowns. This means that the current bout of inflation is transitory, and the sooner-than-expected rate hikes are, in this context, good news as it implies that the US economy is in a better shape than at the Fed’s previous policy meeting on 28 April. The economy will also be able to come off the life support of bond purchases and low rates sooner than previously expected. This prognosis should be good news for the US economy, which now has a better outlook. Unfortunately, however, financial markets are mourning the fact that the current stimulus measures will be reduced sooner than previously expected.
Practically this means very little. We have previously stated that we expect tapering of bond purchases to occur towards the end of this year, with the first actual tapering taking place in either December this year, or January 2022. It may be that the probability of risks has shifted slightly towards December but, for now, we remain of the view that it takes some extreme assumptions to expect tapering to occur earlier than in 4Q21.
The implications for various asset classes
Bond bears have much to bleat about following the Fed’s comments and bleat they will. We have seen the US 10-year bond yield shifting a few basis points higher to 1.56% following Wednesday’s press conference. However, perhaps more telling, US bonds are pricing in that terminal rates for this cycle will be around 2%. This is largely unchanged, meaning that we do not seem to be pricing-in runaway interest rate hikes as the Fed chases inflation, instead just that the Fed might hike rates a little sooner than we (and the markets) had previously expected. We also see this spilling over into SA fixed income markets, where the Anchor Bond Fund will likely record a loss of about 1% today (17 June). This is not the end of the world for a portfolio that has performed rather strongly of late.
Looking ahead, we see SA bonds as being fairly priced on our measures. Nevertheless, we do expect volatility to be a little higher than normal, but bonds should continue, over time, to deliver their 8.9%, 6.25%, or 4.8% returnsm which the Anchor portfolios are targeting and a 10-bpt change is consequently not that meaningful in the greater scheme of things.
Looking at equities, the message that the US economy is stronger than we had previously realised should be a boon for US growth stocks. Higher rates are also supportive of counters such as US banks. Perhaps your interest rate sensitive sectors, including utilities and dividend stocks, will back up a bit. Right now, the market is sulking as it fears the withdrawal of stimulus measures. As this knee-jerk reaction subsides, the stronger economy should support earnings and price growth for equities.
Assets that have zero yield will probably also come under a bit of pressure as the opportunity cost of holding gold, speculative businesses that are not profit-making, and even bitcoin (is this an investment asset?) have increased. Similarly, rate hikes that come in sooner are positive for the US dollar, which has recovered some of its recent weakness. On 17 June, the rand was trading just above R14.00/US$1, which is contrary to expectations highlighted in our 6 June 2021 note entitled Anchor rand view: Used cars and airline tickets give the rand a strengthening bias. In the context of South Africa (SA), we highlight that the country’s current account remains positive on the back of the commodity cycle boom, the current COVID-19 spike and lockdowns will end, and the recently announced electricity reforms are meaningful. Thus, we expect the rand to now trade with a bearish tone in the near term, but many of the factors that have been keeping the rand strong remain intact.
Overall, the Fed’s message that tapering will possibly happen a month earlier than previously anticipated and that an event expected for 2024 might now happen in 2023 has limited direct impact on the markets, in our view. However, we see the knee-jerk reaction as a buying opportunity for various asset classes.
