Fund managers are divided on how many times they expect the US Federal Reserve to cut rates this year, following its decision yesterday to keep rates on hold.
Pictet Wealth Management expects two cuts in September and December while Nomura Asset Management thinks it is too early to rule out a summer cut and has put derivatives in place to profit from surprise cuts in July and September. Nikko Asset Management expects one cut this year, but Fidelity International is bracing itself for no cuts at all. This is all a far cry for the six cuts the market had priced in back in January.
Salman Ahmed, global head of macro and strategic asset allocation at Fidelity, said: “Our base case is zero cuts this year but if progress on inflation continues over the summer months or labour markets start to show some signs of stress, we do see the likelihood of one cut this year rising.
“That said, the US economy remains resilient and yesterday’s release was affected by vehicle insurance and airfare components, which means the bar for cutting to start remains high.”
The lack of consensus among asset managers and economists reflects divisions amongst the Federal Open Market Committee (FOMC) itself.
Eight officials have pencilled in two cuts this year, seven members expect one cut and four predicted none, although no-one is gunning for a hike. Chair Jay Powell has said one or two cuts are both plausible outcomes.
Xiao Cui, senior economist at Pictet Wealth Management, said the Fed has become extremely data dependent and that interest rate decisions will be driven by inflation and employment data. “The labour market is gradually balancing so the burden of proof lies on the inflation side,” she said.
Ahmed agreed: “We have seen the Fed completely abandon any kind of reliance on forecasting to set policy, so we continue to foresee the current data dependency in policy and markets to remain in place.”
What does this mean for bond markets?
Inflation remains stubbornly above target on both sides of the Atlantic, said Richard “Dickie” Hodges, manager of the $2.3bn Nomura Global Dynamic Bond fund, which “implies great caution on the part of central banks in moving to cut rates”.
“For now, as the market continues to guess when cuts will finally be delivered, bond yields will likely trade within a range (as they have for months now),” he said.
Hodges has invested in emerging market bonds, additional tier ones (AT1s) and convertible bonds, which will all “perform well when cuts are finally delivered” and “deliver positive yields in the meantime”.
Nomura also has call options in place on five-year US Treasuries. “The expiries are after the July and September Fed meetings, allowing us to capture some of the upside that would result from a (surprise) cut at that meeting. A form of insurance in case we are wrong,” Hodges explained.
The biggest risk facing bond markets is that the European Central Bank starts to walk back the two to three cuts that are priced in for this year, Hodges warned. “We therefore have credit hedges in place through credit default swap (CDS) index contracts, the notional size of which equates to 31% of the fund’s net asset value.”