A combination of rate hikes together with quantitative tightening could lead to another spike in volatility that will be too much for markets to bear, according to Jupiter Asset Management’s Ariel Bezalel.
Bezalel, who runs the £3.8bn Jupiter Strategic Bond fund, said it will be hard for the US Federal Reserve to tighten policy beyond the already-expected hikes this year without leading to plenty more cracks in the financial system.
“It’s worth highlighting the Fed had begun their quantitative tightening programme at the beginning of 2018 and our concern is that the US central bank is ramping up their quantitative tightening programme,” said the manager.
“A combination of rate hikes together with quantitative tightening will lead to another spike in volatility which will probably be too much for the markets to bear.
“The markets are pricing in something like two more rate hikes in what’s left of 2018 and three rate hikes next year but, as the famous macro trader Alex Gurevich said: ‘The last rate hike in a cycle is very much like a last kiss in a relationship, you rarely think it’s the last one while it’s actually happening’.”
Assets held by the US Fed since 2008
Source: St. Louis Fed
In the wake of the global financial crisis, major central banks adopted unprecedented tactics aimed at stimulating growth through ultra-loose monetary policy.
Between 2008 and 2015, the US Federal Reserve bought bonds worth more than $3.7trn and the UK created £375bn in new money. The European Central Bank has also been boosting the eurozone money supply by buying €30bn of assets each month.
After years of loose monetary policy, the world’s major economy’s central bank stopped buying bonds in 2014 and is currently shrinking its balance sheet, buying a lot fewer treasuries over the coming year.
“In Q3 you are going to see the programme jump to $50bn a month and in Q4 it will go down to $40bn a month,” Bezalel noted.
“It is also worth highlighting that one in three central banks now globally have hiked rates this year; this means 90 per cent of developed markets’ central banks are now running tight monetary policies.”
The FE Alpha Manager said it was no surprise after last year, defined by low volatility, that some mini crises have emerged such as the crypto currency bubble, spikes of volatility, weakening emerging markets, and trade wars.
And, he added, tightening policy seen is currently leading to a very mixed global growth picture.
“In emerging markets, the growth picture is very mixed, led by tightening in policy in China to try somehow to deleverage the economy,” Bezalel explained.
“In Europe data has also been somewhat disappointing not just in the periphery but also in the core coming somewhat below expectations.
“Another issue that we are seeing is LIBOR, that has been rising since 2014. In America it has gone up something like 10x.”
This, he added, is particularly significant in terms of tightening of policy since the funding of over 40 per cent of companies in the S&P 500 is tight to dollar’s LIBOR.
In the US, where economic growth looks pretty robust Bezalel - who also manages the £7.9bn Jupiter Dynamic Bond fund - noted that, as tightening of policy continues globally and domestically, this is going to have “a blowback to US growth”.
US GDP Growth since 2008
Source: World Bank
Trade wars, which have been picking up in intensity more recently, could have an impact to global growth and asset prices, according to the manager.
Another concern for him is the state of financial institutions, which are the key for a sustainable and healthy recovery.
“You need a healthy banking system to support recovery, but there are now warning signals coming through in equity markets: looking at the GSIFI [global systemically important financial institutions] indicator, we can see these are in a bear market,” he explained.
“The flattening of the yield curve is hurting bank margins, the prospects for an inversion of the yield curve is probably scaring some investors and in America there are concerns central banks may have to pay more for deposits, which could also hurt margins.”
He added: “In Europe banks are being weigh down by concerns about the existential risk around the euro and there is concerns about economic activity slowing down, which in turn rising NPLs [non-performing loans].
“There have obviously been some isolated problems within the eurozone’s banking system as well, which is hurting performance of banks' equities and banks' bonds.”
Another leading indicator Bezalel said is watching very closely is the performance of South Korean exports, which are key given the country’s importance as a global manufacturing hub.
“There is a strong correlation between South Korean exports and global earnings-per-share and during the last few months South Korean export growth has been particularly weak; its export growth has now turned negative,” Bezalel warned.
Another important market characteristic the team is observing very closely is the shape of the yield curve, which today in America is the flattest it has been for over 10 years.
“Despite strong economic activity and the robust picture that is being painted, the yield curve is the flattest it’s being for the last 10 years, I will be amazed if the Fed continues to tighten policy if the yield curve does invert,” the Jupiter fund manager added.
Regarding the £3.8bn Jupiter Strategic Bond’s portfolio, Bezalel noted the first quarters of 2018 have seen a mix in performance although the fund had a particularly strong June. The manager has positioned the fund underweight risk with exposure to duration.
Performance of fund vs sector and benchmark over H1 2018
Source: FE Analytics
During the first six months of the year, Jupiter Strategic Bond is down 1.13 per cent compared with a 1.59 per cent loss for the average fund in the IA Sterling Strategic Bond sector and a loss of 1.30 for the IBOXX UK Sterling Non-Gilts All Maturities index benchmark. The fund has an OCF of 0.73 per cent and has a yield of 3.60 per cent.