Stocks Are Not the New Bonds

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Las acciones no son los nuevos bonos
CC-BY-SA-2.0, FlickrPhoto: Jotam Trejo. Stocks Are Not the New Bonds

2016 has been notable for droughts in some places and floods in others. There has been a disconnect, if you will, in normal weather patterns. Lately, we have witnessed a growing disconnect in the financial markets too. Asset class after asset class continues to rise in value despite stagnant global economic growth and flagging corporate profits. Why are investors chasing the market higher? Extraordinarily accommodative central bank policies are the most likely explanation.

With a large fraction of the world’s pool of government bond yields in negative territory, flows that normally would have gone into high- quality fixed income securities are instead finding a home in dividend-paying stocks. This “chase for yield” has pushed up traditional high-dividend payers like real estate investment trusts (REITs), utilities and telecom stocks to historically rich price/earnings multiples. This is the most concrete evidence we have seen in years that investors are substituting stocks for bonds in investment portfolios.

Bonds: Accept no substitute

There are two powerful reasons why stocks are not a substitute for bonds. The first is the relative volatility of the two asset classes. Stocks are historically about three times as volatile as bonds. Investors therefore demand higher returns in exchange for holding these riskier assets. Second, dividend payments to stockholders are not a contractual obligation; there is no legal compunction for corporations to continue to pay dividends. Dividend payments can be — and often are — cut at the first hint of trouble.

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Stock investors need to be particularly mindful of potential economic inflection points. History has shown that markets often become the most euphoric at the most perilous point in the economic cycle. The current US economic expansion is now in its eighth year, while the average business cycle typically lasts five years. The stock market has historically peaked 6–8 months before a recession begins, though forecasting recessions is always challenging. When recessions do hit, corporate profits have fallen by an average of 26% and stock markets have typically fallen by roughly the same amount. Failing to avoid late-cycle euphoria can have severe costs for investors, especially for investors who have been driven into equities for the wrong reasons. 

Don’t be late

Instead of being an equity market latecomer, yield-starved investors might want to consider adding “credit,” or corporate bonds, to their investment portfolios. Pools of investment-grade corporate bonds are currently not cheap by historic standards, but they are not at extremely rich price levels either.  Investors seeking yield can find attractive opportunities in corporate credit, which offers yields similar to or higher than equity dividends, but generally with far less volatility.

Global central banks have been providing novel forms of support for world bond markets with the aim of stimulating economic growth and inflation rates. But in my opinion, sound investment strategy does not include guessing where central bank policy is heading next. The guiding principles of preserving capital while generating growth are vigilance on the fundamentals, caution regarding gains, and the avoidance of fads. Don’t follow raw market emotion, especially when easy money causes the temperature of the markets to rise just as fundamentals fall.

James Swanson is MFS Chief Investment Strategist.

Rising Inflation Pressures May Soon Force the Fed’s Hand

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El aumento de las presiones inflacionistas podría forzar a la Fed a actuar
CC-BY-SA-2.0, FlickrPhoto: Tom Walker. Rising Inflation Pressures May Soon Force the Fed’s Hand

The evidence suggesting significantly higher inflation momentum in the months and years ahead continues to build. A turn higher in the inflation cycle would likely trigger a reaction from the Federal Reserve on monetary policy, with important consequences for investors, according to Stewart D. Taylor, Diversified Fixed Income Portfolio Manager at Eaton Vance.

The latest Consumer Price Index (CPI) number showed that inflation rose a higher-than-expected 0.2% in August, marking the fifth positive CPI print in the last six months. After bottoming at -0.2% in April 2015, headline CPI is now advancing at a 1.1% year-over-year pace. More importantly, the core CPI, which removes food and energy, is rising at a 2.3% annual rate.

However, for the Asset Manager, there are other notable signs that the trend in inflation may have turned higher, including:

  • Services inflation, roughly 70% of CPI, continues to increase at a rate exceeding 2.5%. In fact, the core consumer services component (services excluding energy services) is growing at over 3%.
  • The Atlanta Fed Wage Tracker, a measure that adjusts for demographic changes in the work force, continues to suggest that inflationary wage pressures are quickly growing (see figure below).
  • Commodities have stabilized and started to move higher. For instance, crude oil is more than 30% higher than the low set in January 2016. This deflationary headwind is quickly turning into an inflationary tail wind.
  • Both presidential candidates have voiced support of protectionist trade policies that would potentially boost the prices of goods.
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Taylor writes in the company’s blog that investors and consumers have gotten used to low inflation after the global financial crisis. And to be fair, there are global crosscurrents that could keep inflation subdued. The global economy remains weak, and if growth slows further, the lack of demand could lead to more losses in commodities and goods sectors. Also, in China, some of the most pressured industries are only operating at 60% capacity, and the world’s second-largest economy continues to “export” deflation in areas like steel.

Still, Taylor believes “investors should keep a close eye on any potential shift. Inflation, even modest inflation, acts as a hidden tax on wealth. And if the Fed’s implicit target of confiscating 2% of your wealth every year wasn’t onerous enough, now it is openly making the case that tolerating higher “opportunistic” inflation to drive growth may be desirable.”

“Sluggish CPI growth and falling oil prices may have hidden the potential risks of inflation from investors. Many portfolios are underweighted in inflation-sensitive assets, and a change in the trend would catch many off-guard.” He concludes.

The Growing Role of Smart Beta In New Investment Strategies

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La creciente importancia del smart beta en las nuevas estrategias de inversión
CC-BY-SA-2.0, FlickrPhoto: Aiky RATSIMANOHATRA . The Growing Role of Smart Beta In New Investment Strategies

Lyxor Asset Management has led a research that highlights the growing importance of risk factors and other Smart Beta strategies in generating performance in the current challenging market conditions.

In this research piece, that considers the performance of 3,740 active funds representing €1.2 trn in AUM compared to their traditional benchmarks over a period of ten years, the firm found that European domiciled active funds had a more positive year in 2015, with an average of 47% outperforming their benchmarks, significantly more than 2014 where just 25% outperformed on average.

Looking at the source of this outperformance, the team found a significant part could be attributed to specific risk factors. These ‘risk factors’ describe stocks that exhibit the same attributes or behaviours. Lyxor has identified five key risk factors: Low Size, Value, Quality, Low Beta and Momentum, which together account for 90% of portfolio returns.

European active fund managers for example were overweight Low Beta, Momentum and Quality Factors in 2015, which all outperformed benchmarks. Another aspect of the research compared active fund performance with Minimum Variance Smart Beta indices, which are designed to reduce portfolio volatility. Here the results were even more compelling: whereas 72% of active funds in the Europe category outperformed a traditional benchmark in 2015, only 14% outperformed the Smart Beta index.

These findings demonstrate the increasing role played by Smart Beta strategies that are based on rules that do not rely on market capitalization, as an indispensable pillar of investor portfolio. Factor-investing is one of the various investment strategies referred to as Smart Beta. “In today’s markets characterized by very low interest rates, higher volatility and no market trend in risky asset markets, investors need to look at new forms of portfolio allocation in order to find diversification and generate performance,” Marlene Hassine, head of ETF research at Lyxor Asset Management; commented. “Smart Beta, which can be implemented, either with a more passive or a more active bias, is one of the new tools at the disposal of investors”, she added.

3 Emerging Markets Picks For Active, Fundamentals-Driven Investors

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Midcaps expuestas a cambios estructurales, valores "de pico y pala" y bancos en mercados frontera: oportunidades en emergentes
CC-BY-SA-2.0, FlickrPhoto: w4nd3rl0st, Flickr, Creative Commons.. 3 Emerging Markets Picks For Active, Fundamentals-Driven Investors

“Mid-cap stocks exposed to structural change, ‘picks and shovels stocks’ and undervalued frontier market businesses are three areas of investment that would likely slip below the radar of the more passive and large-cap focused emerging market investor”, says Ross Teverson, Jupiter’s head of strategy, emerging markets. “For active, fundamentals-driven investors like us, they represent a great opportunity,” he added.

Undervalued mid-caps exposed to structural change

Emerging market equities have enjoyed strong recovery since their low in January of this year. Despite this, the valuations of many emerging market stocks remain undemanding and we continue to find a number of compelling opportunities, particularly within the mid-cap universe, where strong growth prospects are not yet reflected in share prices. This is in direct contrast to certain EM large- cap stocks with well-recognised growth prospects, which in recent years, have become expensive relative to company earnings, as increasingly risk-averse investors crowded into a relatively small group of large cap stocks that are perceived to be of high quality.

Examples of these mid-cap opportunities are diverse by geography and sector. One stock that we hold in Jupiter Global Emerging Markets Equity Unconstrained is a Brazilian private university operator, Ser Educacional, which we believe is well positioned to benefit from structural growth in Brazilian education spending. Another is Indonesian property developer Bumi Serpong, a mid-cap stock that is exposed to structural growth in mortgage penetration in Indonesia, which is coming from very low levels. The company is a beneficiary of Indonesia’s very strong demographics: high rates of household formation are creating strong demand for the types of properties that Bumi Serpong are building.

‘Picks and shovels’ stocks

They say that in a gold rush, the ones that make the most money are the suppliers of the tools you need to find gold rather than the miners themselves. The modern equivalents of these businesses in EM are companies that give exposure to well-known and significant trends or structural changes like the growth of electric vehicles, the move towards industrial automation or the switch to renewable energy. Take BizLink in Taiwan. A key supplier of wiring harnesses to one of the most advanced manufacturers of electric cars, Tesla, it is held in Jupiter Global Emerging Markets Equity Unconstrained and Jupiter China Select. BizLink may be the less glamorous of the two businesses, but it is making high and consistent margins while Tesla itself, while ground-breaking, is some way from making a profit.

Or there is Chroma, another Taiwan-based company held in Jupiter Global Emerging Markets Equity Unconstrained. Chroma provides testing equipment to a number of different areas within clean technology and renewable energy, including solar power, electric vehicle batteries and LEDs. Because its management team has a culture of paying out free cash flow to shareholders, investors in the company typically receive a decent dividend. What’s more, because Chroma is a key supplier to manufacturers within its business areas, it can afford to make the pricing of the equipment it sells very stable.

Frontier-market banks

Large state-owned banks make up a big part of the Emerging Markets index, which means that these are the banks an investor in an EM ETF might own. Hanging over these largely government- controlled banks, however, is a great unknown. A history of undisciplined or politically incentivised lending has left many of these banks with a level of non-performing loans that is likely to be much higher than official numbers suggest. It is hard to quantify exactly how big the problem will be. A number of frontier market banks, in contrast, trade at similar valuations to their larger EM peers but with better asset quality, higher returns and superior long term growth prospects

Specifically, we like frontier markets banks which either have a strong deposit franchise or are building a strong deposit franchise. Depositors entrust these banks with their money because they provide a good branch network, easy access to money, and are considered a safe place for them to keep their cash. There are good examples in Georgia, where we own Bank of Georgia, in Pakistan, where we own Habib Bank, and in Nigeria, where we own Access Bank. By operating the traditional retail banking model, these banks make a high return by taking deposits on which they pay a low level of interest and then lending to blue chip corporates. It’s also less risky than an alternative model (which is to borrow money from the wholesale money markets and then lend to riskier borrowers). In frontier markets, this operating model has led to high returns and good growth prospects as a result of underpenetrated consumer credit.

$100M Global Private Banking Team joins Investment Placement Group’s Miami Office

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Investment Placement Group suma un equipo que gestiona 100 millones en Miami
CC-BY-SA-2.0, FlickrMaurico Assael, Mildred Ottenwalder and Roberto Lizama. $100M Global Private Banking Team joins Investment Placement Group’s Miami Office

Investment Placement Group (IPG), an Independent Broker Dealer and IPG Investment Advisors, a Registered Investment Advisor, announced on Tuesday that former Wunderlich Securities advisors Maurico Assael, Roberto Lizama and registered sales assistant Mildred Ottenwalder have joined the firm’s newly established Miami, Florida office which is managed by Rocio Harb.

“We are very excited to become part of IPG.  With our diverse client base in Latin America and the United States, IPG is the right platform and has the expertise to allow us to offer high quality service to our clients” said Lizama.

“The commitment of IPG to Latin American Investors was a key factor in our decision to join the firm. From the ownership, management team and support staff the knowledge of the international markets and needs of the investors are second to none” adds Assael.

“Maurico, Roberto and Mildred are highly capable and experienced team.  They are the perfect fit for our firm and I am confident that they will have continued success at IPG”, said Gilbert Addeo, COO and Head of Business Development of IPG.

The Miami, Florida office was established last July.

How QE Distorts Prices

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¿Hasta dónde pueden caer los activos libres de riesgo?
CC-BY-SA-2.0, FlickrPhoto: Linus Bohman. How QE Distorts Prices

One of the main differences between free market and communist economies is the role of prices. In free market economies, prices play a central role as they aggregate valuable information over demand and supply in a single figure that guides economic agents – producers and consumers – to make their choices. In communist economies, on the other hand, prices do not incorporate any information, since what is produced and consumed is defined in a plan decided by a central authority.

A prime example of free market economies are financial markets, a virtual place where millions of sellers and buyers continuously exchange standardised products. In these markets, and more than in any other markets, prices play a key role. This is the very reason why trade takes place.

A Quantitative Easing (QE) programme, as decided by a central bank, is a plan that consists of buying large quantities of assets whatever the price is. As a conse- quence, prices lose their precious information content that normally enables investors to switch meaningfully between different asset classes. One example for this is the current development of government bond yields. It makes no sense that long-dated German government bonds have a negative yield, nor does the fact that Italian yields are lower than their US counterparts. Even more shocking is that the Bank of England wasn’t able to buy enough gilts during the first days of its new QE, even though the price offered to pay was high and above market prices. Furthermore, it is common knowledge that gilts are overvalued.

QE programmes are designed differently across central banks, including to various degrees sovereign bonds, corporate bonds, asset-backed securities and equities. They all have in common to purchase mainly sovereign bonds. The yields of these government bonds play a central role in asset allocation as they are seen as risk free rates and thus set the basis for the pricing of all assets. Consequently, the distortion in this specific market segment, reinforced by negative interest rate policies of central banks, has a cascading effect on other assets, thus leading to mispricing of all financial assets.

According to the Financial Times, the market value of negative-yielding bonds amounts to USD 13.4tn, a mind-boggling figure that shows the extent of the price distortion in this key market segment. In addition to central bank purchases of other above-mentioned assets which directly distort prices of risky assets, liquidity and risk premiums are further altered by investors’ thirst for yields, forcing them to take more risk for a given return.

No matter how strongly distorted each individual market price is, asset prices remain consistently priced vis-à-vis each other. For example, the yields of US treasuries and German bunds – two assets that share very similar risk characteristics in the investors’ eyes – become similar once the currency hedging costs are taken into account; and this despite different economic conditions and different central bank behaviours. Equity markets have all gone up significantly, even to new highs in the US, as the thirst for yields has obliged investors to buy equities despite an overall general pessimism and meagre growth prospects. The same is true for corporate bonds. Finally, the VIX Index, nicknamed the fear index, is close to its lowest level, as if the world economy would be looking forward to a blue sky outlook.

While mispricing can be observed in all asset prices, financial markets behave consistently, in sync, according to their own logic. We are asking ourselves how long this situation will last and how far it can go. The situation will last as long as central banks’ credibility remains intact, or in other words, as long as they are willing and able to act convincingly in the eyes of market participants. And it can go as far as the most powerful and thus most credible central bank will be able to set prices at ridiculous levels. If this proves to be true, risk-free yields are set to converge to the lowest level and risky asset prices to increase virtually in- dependently from economic fundamentals. Like in communist economies, the outcome is ultimately equality, not fairness.

Three potential symptoms could indicate that this situation is in its terminal phase. First, the credibility of central banks and governments is directly challenged, resulting in rising and diverging government bond yields as risk is repriced. Second, the currency market absorbs a part of the mispricing by rebalancing economies and markets via sizeable exchange rate adjustments. Third, the loss of credibility is directly reflected in the domestic loss of purchasing power, in other words inflation. This type of inflation, however, is not due to the usual too much money chasing too few goods, but to a lack of confidence in the government. This can potentially lead to hyperinflation, as extreme events such as Germany in the 1920s, Hungary in 1946, Zimbabwe in the late 2000s and Venezuela today remind us.

While we do not see any of these symptoms flourishing, a way to protect against this eventuality would be to invest in gold, an asset which is not under the direct control of institutions and an alternative to cash whose costs have increased dramatically with the introduction of negative rates.

In this context, the case of Japan is interesting in many respects and is a source of hope in the view of our analysis. For more than two decades, Japan has experienced a zero economy. This is an economy where growth, inflation and yields have been low. According to the IMF, government debt to GDP has been multiplied by 5 since 1980 to about 250% nowadays and is unsus- tainable. In addition, Japan has experienced various government and central bank policies with essentially no effect: yields have not repriced and growth and inflation have not come back. The Japanese yen has moved in the opposite direction to the Bank of Japan’s intention, indicating that investors are challenging the credibility of the Nippon central bank, but without triggering a full-fledged credibility crisis. Japanisation of financial markets and Western economies could thus be a benign outlook.

The wide use of unusual monetary policies in the Western world, in particular QE, has distorted massively all asset prices. While assets are mispriced, it remains true that they are consistently priced vis-à-vis each other. As long as central banks remain credible, this situation could last longer. Currently, no terminal phase symp- toms are observed, which means that the convergence in prices should continue. Gold is a good hedge against an abrupt end of this system, unless we all become Japanese.

Sayonara (さようなら) .

Yves Longchamp, is Head of Research at ETHENEA Independent Investors (Schweiz) AG.

Capital Strategies is Ethenea  distributor in Spain and Portugal.

 

WE Family Offices and MdF Family Partners Join Forces to Support the Launch of a London-Based Independent Family Office

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WE Family Offices y MdF Family Partners se asocian para lanzar un nuevo family office en Londres
Michael Parsons, CEO at Wren Investment Office - Courtesy photo. WE Family Offices and MdF Family Partners Join Forces to Support the Launch of a London-Based Independent Family Office

American based WE Family Offices and MdF Family Partners, an independent multi-family office advisor in Spain joined forces last year to broaden resources and enhance client service abroad. The two firms formed a strategic alliance – remaining separate companies but creating ways to collaborate and share resources.

These collaborations include their support of the newly launched Wren Investment Office, a London-based, independent wealth advisory firm serving ultra-high net worth families. The association and collaboration of WE, MdF and Wren represents a global alliance of independent family offices and comes at a time when wealthy families are seeking advisors that combine local roots and a global outlook and capability to help them manage their increasingly globalized wealth enterprises. Though WE and Wren remain separate firms, our association strengthens our ability to serve families all over the world.

Mel Lagomasino, CEO of WE Family Offices, and Michael Zeuner, managing partner of WE, will serve as non-executive directors at Wren. “The launch of Wren Investment Office is an exciting development. The philosophy of sustaining family wealth by managing it like a well-run company has been highly successful here in the US and it is a philosophy our colleagues in Europe fully subscribe to,” Lagomasino comments. “The team at Wren shares our commitment to independence, a simple fee structure and adherence to always putting clients’ interests first. We look forward to working with Wren. Our alliance with Wren is a significant step toward building a truly independent, aligned and global wealth advisory service platform for ultra-wealthy families.”

Wren Investment Office will serve as an independent family advocate, helping families to view their wealth as an enterprise and manage it as they would a business. The three firms, Wren, WE and MdF, will remain separate companies and will continue to advise and serve clients independently, but through their developing alliance will collaborate to leverage the investment opportunities, relationships and services of each firm. This will provide wealthy families access to a global platform with servicing options in the UK, Europe and the United States. This comes as WE Family Offices surpasses $5 billion in assets under advisement, while serving 70 global client families. MdF has assets under management and advice of approximately €1.5billion serving over 30 clients from its offices in Madrid, Barcelona, Geneva and Mexico.

Wren will be operating from its new premises at 8 Wilfred Street, London SW1E 6PL and has Michael Parsons as its CEO.

MFS Launches Global Opportunistic Bond Fund

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MFS lanza un fondo de renta fija flexible diversificado a escala mundial
CC-BY-SA-2.0, FlickrPhoto: Robert Spector and Richard Hawkins, fund's lead managers. MFS Launches Global Opportunistic Bond Fund

MFS Investment Management recently announced the launch of MFS Meridian® Funds – Global Opportunistic Bond Fund, a flexible fixed income fund designed to generate returns from a diversity of alpha sources through variable market conditions.

The investment strategy, available to investors through the Luxembourg-domiciled MFS Meridian Funds range, is based on the belief that global fixed income markets offer a diverse range of opportunities to add value, including global sector allocation, security selection, duration and currency management over a market cycle.

Primarily, the fund focuses its investments in issuers located in developed markets, but may also invest in emerging markets. The fund will invest in corporate and government issuers and mortgage-backed and other asset-backed securities, as well as investment-grade and below-investment-grade debt instruments. Through this diverse opportunity set, the fund aims to allocate risk where it is most attractively priced in order to generate returns.

While the portfolio has the ability to meaningfully allocate to various sectors, including riskier segments of the fixed income markets, the fund utilises a benchmark-aware approach that seeks to balance higher yield and total return potential while still providing the diversification benefits traditionally offered by fixed income. However, it is important to remember that diversification does not guarantee a profit or protect against a loss.

‘The need for enhanced fixed income return potential is real in the current slow-growth, low-rate environment. In our view, different sources of alpha are likely to drive performance, depending on market conditions, and so the ability to allocate across different opportunities enhances efforts to generate performance’, said Lina Medeiros, president of MFS International Ltd.

In an effort to manage exposure to particular areas of the markets, the fund is expected to use derivatives primarily for hedging and/or investment purposes.

Richard Hawkins and Robert Spector serve as the fund’s lead managers and are responsible for asset allocation and risk budgeting in the portfolio. They work with a group of sector-level portfolio managers.

In addition to providing insights on relative value for their sectors, this group is responsible for buy and sell recommendations within their sectors.

This highly experienced team has a long track record managing global portfolios, with extensive investment experience in various asset classes and regions around the world.

Standard Life Investments Launches Enhanced-Diversification Multi-Asset Fund

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Standard Life Investments lanza un fondo multiactivo con estrategias que mejoran la diversificación de la cartera
CC-BY-SA-2.0, FlickrGuy Stern, Head of Multi-Asset Investing.. Standard Life Investments Launches Enhanced-Diversification Multi-Asset Fund

Standard Life Investments, the global investment manager, has launched the Enhanced-Diversification Multi-Asset Fund (EDMA) in response to a growing client demand for multi-asset growth funds that manage downside risk.

EDMA is part of its multi-asset range for investors who want to balance capital growth against volatility in financial markets. With EDMA, the fund manager aims to generate equity-type returns over the market cycle (typically five to seven years in duration) but with only two-thirds of equity market risk.

Guy Stern, Head of Multi-Asset Investing, explained “the Fund differs from many traditional multi-asset growth approaches. EDMA holds a range of market return investments (such as equities, bonds and listed real estate); however, we also use enhanced-diversification strategies which seek to provide additional sources of return and high levels of portfolio diversification“.

“By taking relative value positions as well as making investments in the currency and interest rate markets, we can develop risk relationships that are quite different from traditional investments. These types of investments are valuable when constructing a diversified multi-asset portfolio as we would expect them to limit downside risk during market falls”.

EDMA is co-managed by Jason Hepner, Scott Smith and James Esland and benefits from the expertise of SLI’s established and award-winning multi-asset investing team. The Fund is a Luxembourg registered SICAV and is a sister fund to the Enhanced-Diversification Growth Fund OEIC launched in November 2013.

Is the Fed Bluffing?

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¿Se está tirando un farol la Fed?
CC-BY-SA-2.0, FlickrPhoto: Viri G. Is the Fed Bluffing?

In the days prior to the Federal Reserve’s annual Jackson Hole Economic Policy Symposium at the end of August, senior Fed officials started to make the case that markets had become too sanguine about further rate hikes this year. Janet Yellen’s conference opener restated the Federal Open Market Committee’s tightening bias, saying “the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time.” There was no softening or policy pivot here. In fact, she added that “the case for an increase in the federal funds rate has strengthened in recent months.” That was the most forceful endorsement of another rate hike from Yellen yet.

The rest of the conference, titled ‘Designing Resilient Monetary Policy Frameworks for the Future’, produced few new insights. The agenda focused on policy efficiency, especially what can be done to improve the pass-through of monetary policy to broader financial markets, and emphasized greater coordination between fiscal and monetary policy. Other speakers argued for maintaining the large Fed balance sheet for the foreseeable future and affirmed Chair Yellen’s view that the current set of policy tools – including the ability to pay interest on excess reserves, large scale asset purchases, and explicit forward guidance – are sufficient to deal with future downturns.

Yellen even provided model-based estimates showing quantitative easing and forward guidance would be as effective as allowing policy rates to fall deeply into negative territory in a future recession. That’s as clear a repudiation as you will get from her of the negative interest rate policy followed by the European Central Bank (ECB) and the Bank of Japan (BOJ). One presenter at the symposium, Marvin Goodfriend, did promote the merits of unencumbering interest rate policy at the zero bound. He argued that the current low levels of nominal bond yields leave little room to push short rates much below longterm interest rates. Yet, for such a policy to function effectively, we would have to seriously reduce Americans’ preference to use cash for transactions, which would resist negative rates. It’s hard to see negative interest rates as anything but an interesting thought experiment for the Fed.

Markets moved sideways

Reflecting the uncertainty about US monetary policy, both equity and the broader fixed income markets trended sideways last month. Both the S&P 500 and the Barclays Aggregate index were essentially unchanged in August; incidentally, both are up about 6% for the year so far.

What still worked in August was the reach for yield. The Barclays High Yield index gained 2%, pushing its year-to-date performance to over 14%. Also not surprising in an environment of possible Fed rate hikes was that financials were the best performing sector in the S&P 500 and the US dollar gained a few tenths of a percent against other major currencies.

Fundamental contradictions

Janet Yellen’s manifestly improved confidence has some backing from US fundamentals. While economic growth in the second quarter was revised down to just 1.1%, much of the weakness was due to a decline in inventories, typically a transitory headwind to growth. In fact, private domestic demand – consumption, housing, and business investment – increased at a more impressive 3% rate, up from just 1.1% in the first three months. Job growth has rebounded, too. After averaging just 84,000 new jobs in April and May, the following two months saw that trend increase to 274,000. Most forecasters are looking for a solid 2.7% growth rate in the current quarter; our forecast, at 3.2%, is even more optimistic. So, the Fed’s central case of a moderately growing economy that will continue to push the unemployment rate lower remains strong.

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Still, not all the evidence is pointing in the same direction. The two main US consumer confidence surveys have been on diverging trajectories in recent months. One showed consumers feel their current circumstances haven’t been that good since the summer of 2007, which suggests the pace of consumer spending should accelerate. The other survey has deteriorated below last year’s average, pointing more to weaker spending. It’s a similar story on the manufacturing side: One of the two major purchasing managers’ indexes supports a tentative reacceleration, while the other just indicated a renewed contraction in manufacturing activity.

The Fed may not pull the trigger this year

Those contradictions are not enough to change the Fed’s central, moderate growth case. But they likely sow enough doubt about how sustainable a summer growth rebound is. Doubts like these are what persuaded the FOMC in each of this year’s five meetings not to raise rates. We think that is essentially what the committee faces when it meets later this month. With inflation still well below the Fed’s 2% target, the FOMC is under no pressure to raise rates other than the pressure it has created itself.

After the December 2015 rate hike, the FOMC still provided forward guidance of four additional increases this year. In March the committee cut that guidance to just two. The second half of the year should look similar to 2015, when the FOMC cut guidance in September from two to just one rate hike for the year and delivered that hike at the December meeting. The added complication this year is, of course, November’s presidential election, which may lead to an increase in economic policy uncertainty. That’s the main reason our forecast schedule has the next rate hike penciled in for the first quarter of 2017 and not December 2016.

Another rate hike will do very little to change the outlook for Treasuries. The Fed may be contemplating further policy tightening, but the ECB, the Bank of England, and the Bank of Japan are still looking for policy easing. That should keep yields low in much of the rest of the developed world, which serves as a valuation anchor for longer dated US Treasuries. However, US inflation trends are gradually improving behind the scenes. After averaging close to 0% for most of 2015, it took just three months for headline inflation to jump to a new 1% trend earlier this year. The same base effects are likely to push next year’s average above 2%. That should modestly pull up longer term Treasury yields. We still expect 10-year Treasuries to trade around 1.5% at the end of this year and around 2% at the end of 2017.

Markus Schomer is managing director y Chief Economist de PineBridge Investments.

This information is for educational purposes only and is not intended to serve as investment advice. This is not an offer to sell or solicitation of an offer to purchase any investment product or security. Any opinions provided should not be relied upon for investment decisions. Any opinions, projections, forecasts and forward-looking statements are speculative in nature; valid only as of the date hereof and are subject to change. PineBridge Investments is not soliciting or recommending any action based on this information.