BY ERIC VANRAES
THIS IS CLEARLY A DOVISH HIKE
The Fed will remain extremely cautious as they confirmed their growth and inflation targets but they know that Q1 2017 growth is lower than anticipated. Is this hike a one-off? Nobody knows, including the FOMC members. The Fed confirmed that the unemployment rate will stay low and decrease towards 4.5% in 2019 but recent figures are probably too optimistic due to weather conditions (there was no snow at all in Chicago in January and February!). They also confirmed that 2 more hikes are scheduled in 2017 but reaffirmed that an imminent hike is unlikely.
THIS HIKE IS A NON-EVENT
Why? Two major elements must be considered: Firstly, the Fed Funds are no longer a real interest rate benchmark. The 3 Month $ LIBOR reached recently 1.14%, the 12 Month $ LIBOR reached 1.8%, 50 bps above the 2y US Treasury yield (1.3%). These Money Market rates are crucial as they are the benchmarks for many loans, leasings, mortgages and rents but this hike is just a readjustment of official rates to Libor rates.
Secondly (but even more importantly), the level of the Fed Fund rate does not really matter because the Fed’s most important decision will be “how do we manage the huge liquidity burden generated by Quantitative Easing?” The size of the Fed’s balance sheet is not decreasing – in other words, we are watching and forecasting rate hikes instead of analysing the only problem that matters: the Fed is not draining liquidity and does not signal it will do so soon. This is incredibly dovish!
WHAT ARE WE DOING?
We substantially decreased the duration of our USD Funds last month when we decided to build a short position in the 10Y Note Future market. At around 2.60%, we cut one third of this short position but remain extremely cautious. 10y Treasuries could climb to 3% but should any indications emerge of an economic slowdown or a correction in the S&P 500, this could immediately push yields back to 2%. Our second conviction is that the long end of the curve will flatten. We are long 30y Treasuries hedged by a short 10y Future position (duration neutral) and we remain long 30y TIPS because inflation pressures will persist. Our third conviction is that this “dovish rate hike policy” will not prompt a collapse of Emerging Markets.
The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Funds as of 16/03/17 and are based on internal research and modelling.