By Deepika Sharma, Astor Investment Management, Managing Director of Investments
The market is pricing in only a 20% probability of a hike at Wednesday’s Fed meeting and the possibility of a hike by December stands at a 51.8%. In January this year, on the heels of the first Fed hike in years, markets were still assigning more than a 50% probability to a September hike. So, what has changed?
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Let’s look at the Fed’s scorecard.
- The labor market is steady but showing signs of deceleration. Claims are still at all-time lows but payroll growth has definitely slowed. Unemployment and part-time U6 underemployment rates have come down. But, the Fed’s Labor Market Conditions Index (LMCI),which combines 19 labor market indicators including quit rate, wages and part-time workers, has been negative for 7 out of the last 8 months.
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- Fed has been paying attention to the dollar strength and resulting weakness in manufacturing, but one month’s weak manufacturing PMI we believe won’t significantly affect the Fed’s decision. If we look back at December when the Fed finally raised rates by 25 bps, ISM was at 48 vs. 49.4 in August.
- Inflation is under control. PCE Inflation came out to be below target at 1.6%, and expected to hit 2% only over the next few years. Because of this, the employment situation & global risks remain the top most factors for the Fed.
Even though the probability of a hike is low, a surprise decision can’t be ruled out. What will happen if the Fed does hike now or in December? While it’s clear how the front end of the curve will react, the outlook for US growth is key to understand how the dollar and longer-dated bonds will move in response to a Fed hike news. Our view is that unless economic conditions deteriorate significantly in the next few months, we still expect a stable to steeper yield curve and higher rates by early 2017. Just like in December 2015, a single hike is not relevant, it’s the path of interest rates that matters for investors.
We continue to favor low duration in our fixed income portfolios given the extent of the rally in the U.S. Treasuries post-Brexit. The iShares Aggregate Bond ETF AGG has risen in duration from 3.7 years in 2008 to 5.5 years so short duration ETFs (SHY, GSY, MINT, NEAR) are worth a look. We expect that higher yields will be beneficial for floating rate bonds (FLOT, FLTR, FLRN) and leveraged loans (BKLN, SRLN) and negative for bonds with prepayment risk, mainly higher coupon mortgages. Interest-rate hedged strategies (LQDH, THHY) could be an option for some investors to reduce rate sensitivity while maintaining bond exposure.
Deepika Sharma is the managing director of investments and portfolio manager at Astor Investment Management, a participant in the ETF Strategist Channel.
Disclosure Information
All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.
At the time of writing, Astor Investment Management held GSY, BKLN, AGG, NEAR and SRLN among its universe of ETFs included in its multi-asset portfolios. Astor Investment Management is a fundamentally-driven quantitative asset manager that seeks to empower clients with economics-based tools and portfolio solutions to reduce risk and help attain investment goals. Contact Astor at 1-800-899-3230 or info@astorim.com. For a complete list of relevant disclosures, click here. 309161-488