What We Know
By Heather Rupp, CFA, Director of Communications and Research Analyst for Peritus Asset Management, Sub-Advisor of the AdvisorShares Peritus High Yield ETF (NYSE Arca: HYLD)
All eyes are on September 21st. Just over a week or so ago, people seemed to feel a September rate hike was unlikely, now over the course of a week and a bit of hawkish Fed-speak, many now seem to believe September may actually be in the cards. On Friday we saw security prices fall across the board, with both risk assets and Treasuries taking a hit.
Financial markets across the world have been taking their cues from central banks for years now, and last week was just another example. Over the week, the ECB (European Central Bank) decided they would not take further easing measures at this time. We know the Federal Reserve wants to at some point begin raising rates, thought timing uncertain. What happens if the Federal Funds Rate increases 25bps or even 50bps over the next six months? Do Treasuries all of a sudden spike? For instance, could our 10-year move up 0.5% or even 1%, even in the face of rates for 10-year government bonds below zero to slightly above that in many other developed nations around the globe?
In 2013, we saw the “taper tantrum” as the Fed started tapering off their quantitative easing measures, with the 10-year yield/rate beginning its move up in May 2013 from around 2% to end 2013 at 3% only to see bond yields fall back to just over 2% by the end of 2014. The move in 2013 was all in anticipation that the Fed would be lessening their easing measures over time and rates would eventually rise, though most of the “tapering” occurred during 2014 as Treasury rates were falling off their 2013 highs and that first actual Federal Funds Rate increase didn’t come until two years later. In 2015, we saw the 10-year Treasury open the year around 2.2% and had lots of ups and downs, as anticipation about the first rate hike began to gain momentum, with yields peaking at just under 2.5% in June 2015 and staying above 2% until starting its steady decline in late December and into January 2016 after the Fed undertook their first increase on December 16th, 2015. It would seem over the last few years, the anticipation has taken more of a toll on markets than the reality of a rate rise. Will this time be the same? It may well be given the global environment we are facing.
We know a few things that I believe should help us frame how we view a rate increase. First, we know that this is a VERY measured Fed. I don’t think we would expect aggressive action from them. We know they want to raise rates to at least start somewhat on that path and give them some policy tools for the future should markets decline, but if they did take an increase and the market all of a sudden started tanking, we would expect they’d hold off on further increases until they saw market stabilization. They certainly don’t have blinders on to market reactions to their policy moves.
We also know that rates across the globe are exceptionally low. Yes, the German ten year has moved back into positive yield over the past few days, but it along with Japan is still virtually zero. And yields through much of the rest of the developed world are sub 1%. If US rates were to move up much, it seems likely to us that buyers from around the world would step in and buy our bonds on the back of our comparatively better economy—and we’d expect this buying activity would constrain the upward move in Treasury yields.
We also know that economic data has had its own fits and starts over the past several years; we haven’t seen a sustained strong and upward movement. And we know this Fed is “data dependent.” If the data does take a clear path toward improvement and the Fed does see further room to raise rates above and beyond one or two rate increases over the next year or so, investors need to keep in mind that increase will be in the face of a clearly improving economy. And an improving economy is generally good for markets, so that could provide an offset to higher rates. Given how measured and slow to act today’s Fed is—for instance, even if we get a September rate increase, it would have been more than nine months since the previous hike—and the fact that global growth continues to stall, we don’t think that the data will be there for a massive rate increase in the foreseeable future.
We will at some point need to come out of the environment of quantitative easing. It took from 2008 to December 2015, so seven years, for the Fed to make their first move and it may well take years for them to get out of it, barring no further cyclical downturn in the meantime, at which point they may need to revert back. We do expect a move up to be slow and measured. Equities are trading at historically high valuations in the face of declining earnings, so we feel that a correction there is likely overdue and warranted, whether it be to a potential rate increase or something else. In the high yield market, we continue to see valuations (spreads) still around historical median levels (see our piece “Looking for Yield?”) and if we look at history, high yield bonds have actually performed well during rising rate environments (see our piece “Strategies for Investing in a Rising Rate Environment”).
Although information and analysis contained herein has been obtained from sources Peritus I Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. Information on this website is for informational purposes only. As with all investments, investing in high yield corporate bonds and loans and other fixed income, equity, and fund securities involves various risk and uncertainties, as well as the potential for loss. Past performance is not an indication or guarantee of future results.