News that the Federal Reserve has put its interest rate hike programme on pause may not be enough to spark an extended market rally as seen in 2016, according to JP Morgan Asset Management’s John Bilton. 
Bilton, the asset manager’s global head of multi-asset strategy (pictured), said while current policy is supportive of markets, it is unlikely that the rally will be maintained in the long term.
The strategist said recession risk – one of the key concerns among markets towards the end of the last year – had become more muted this year, paving the way for the recovery during the first quarter.
“The objective probability of a recession in the next 12 months remains low by late-cycle standards,” he said. “And with the Fed communicating a pause in its rate hiking cycle, we think the business cycle is probably extended by a couple of quarters.”
He said the dovish pivot by the Federal Reserve and other central banks has likely extended the cycle a little, contributing to the sharp rebound in risk assets during the first quarter.
Performance of index YTD
Source: FE Analytics
Since the start of the year, the developed markets-focused MSCI World index has made a total return of 8.69 per cent – in sterling terms – compared with a loss of 11.35 per cent during the final quarter of the year.
However, while markets have made a strong start to 2019 it is unlikely to be reminiscent of the market rally of 2016, according to Bilton.
“We are unconvinced that the Fed’s dovish pivot fired the starting gun on an extended, 2016/17-style rally,” he said.
“Financial conditions may have eased, but the economy is in later cycle, and there is less scope for an unleashing of pent-up demand.
“For all that, we have observed enough of the vagaries of post-global financial crisis central bank manoeuvrings not to want to stand in the way of easier policy.”
While the new Fed ‘dot plot’ suggests that there will be no new rate rises until 2020, the multi-asset strategist has been more cautious suggesting that the “easy policy tone” could start to reverse should inflation pick up.
“We acknowledge that Fed members have tacitly stated they will run the economy a little ‘hot’ but tolerating inflation a couple of tenths of a percent above long-run targets strikes us as tepid at best,” said Bilton.
Federal Open Market Committee ‘dot plot’
Source: FE Analytics
It’s a view shared by BlackRock’s Ben Edwards, who said that any improvement in the global economy could prompt the Federal Reserve to move back to tightening regime.
After the Fed’s well-signposted December rate hike, financial conditions have recovered to October/November levels, said the BlackRock Corporate Bond fund manager.
“They can be a victim of their own success as some input costs come down and growth stabilises, labour markets broadly tighten and wage pressures might continue to pick up,” said Edwards.
“Finance conditions could ease to a point where the Fed might need to come back in and put one or two further rate hikes on the table and [then] we may experience some volatility like last year.”
There also remain a number of unresolved challenges for markets from the end of last year, said JP Morgan’s Bilton, that could further impact the outlook for risk assets.
“We can’t shake the nagging feeling that asset markets are merely desensitised to the macroeconomic challenges that fuelled the late-2018 sell-off even as those issues still lurk just beneath the surface,” he said.
One of the unresolved areas carrying over from 2018 is trade, where data has been subdued more recently as the US-China dispute continues to drag on.
Any potential deal agreed between China and the US would likely to provide a boost for markets, said the JP Morgan strategist, although both sides remain divided on many issues.
The spat has also impacted European exporters, despite not being directly targeted by either economic superpower, which have come on top a slide in domestic demand and increased political tension.
As such, a resolution to the ongoing dispute would also be beneficial for European companies, although a pick-up in sentiment is unlikely until after the European Parliament elections in May, said Bilton.
“While the economic outlook is neither hot nor cold, Goldilocks it isn’t,” he explained, adding that the firms is maintaining its underweight position in equities.
Share prices, Bilton said, have been supported by subdued earnings and easy monetary policy but given the late-cycle environment, there were few catalysts for a strong upside to earnings.
Within the asset class, the firm’s most preferred region is the US, with European companies out of favour, while a softer US dollar also lends support to emerging market stocks.
Performance of indices over 1yr
Source: FE Analytics
The strategist said JP Morgan’s multi-asset team is also sticking by its overweight position to duration and has taken cash holdings back to neutral given slower growth and more dovish US policy.
Its asset allocation, said Bilton, currently reflects an environment that supports more carry – or interest – than capital growth, which is where the firm has been adding more risk.
This has been seen in the multi-asset portfolios where credit holdings have moved to a small overweight, with US and European high yield preferred and emerging market debt backed over investment grade.
He concluded: “Our allocation today could be reasonably interpreted as a staging post. But in any journey, when the map is a little unclear, a staging post can be a welcome opportunity to reassess and, most importantly, gather further guidance for the next leg.”