There are clear indications that the Federal Reserve is going to raise interest rates for the first time in more than nine years this September. Kommer van Trigt, manager of the Rorento Total Return Bond Fund, looks at the arguments for and the likely effects of a rate hike.
The Fed is on course to raise rates in the autumn. In mid-June, Fed chair Janet Yellen stated that thanks to the strengthening economy there is room to raise the federal funds rate. This official interbank rate currently stands at an all-time low of 0.125%. She also made it known that in future rates would rise less rapidly than the Fed had originally anticipated.
In a normal cycle, rising inflation and the threat of an overheated economy resulting from too high a growth rate often trigger an interest rate hike. At the moment this is certainly not the case. In the last three years, core inflation in the US has fluctuated between the one and two percent level and since 2010, economic growth has moved in a bandwidth of one to three percent.
In previous cycles, economic growth was around four percent at the point when the Fed implemented a first rate hike. On the basis of those figures, a rate hike seems by no means a necessity. That makes you wonder why Yellen alludes with such certainty to a rate hike after the next Fed meeting in mid-September.
“One important reason for a rate hike is that the central bank want to build up its weapon reserves for the future”, explains Van Trigt. “If the US economy falls into recession, there is currently no room whatsoever for a further rate cut. The Fed wants to ensure that it does not have to rely on taking a whole range of unorthodox steps in such a scenario.
What Yellen also wants to prevent is a repeat of the so-called ‘Taper Tantrum’ of 2013, when a wave of selling engulfed the bond market after former Fed chair Ben Bernanke alluded to higher rates. “There is a much better chance that financial market stability will remain intact if the increase in interest rates takes place gradually, and if the market is made aware of the Fed's plans”, explains Van Trigt to clarify this second argument for raising rates without it being economically necessary to do so.
'Clear communication by the Fed is not without its dangers'
In such a scenario, fixed income markets at least have plenty of time to come to terms with the idea of a rate hike and up to now the central bank has been pretty successful in managing market expectations. According to Van Trigt, this scenario is not without its dangers, however: “A rate hike is approaching, but the market is only pricing in a minimal rise of 12.5 basis points in September and 25 basis points in the months that follow. If these rate hike steps occur earlier than planned this could have a major impact on the prices of short-dated paper."
The approaching rate hike in the US is the reason why we have reduced Rorento's exposure to those segments of the bond market where this can hit hardest. “The fund is still invested in US bonds, but its interest rate sensitivity (duration) for bonds with a maturity of seven years or less has been brought back to zero”, says Van Trigt. Another part of the bond market that is vulnerable to rising US rates is emerging market debt.
There are better prospects for short-dated Australian bonds, given that the central bank there is still busy cutting rates. “By cutting back the duration for short-dated US paper and overweighting Australian bonds, we have ensured that Rorento is as well-positioned as it can be to cope with any negative effects of rising rates in the US”, summarizes Van Trigt.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.