Savvy investors should be watching equity and credit markets closely in order to take advantage of a future US Federal Reserve rate hike, says Pimco.
In a recent report entitled Supply-side yellenomics is (slowly) losing its grip on markets, Pimco argued that the Fed “can no longer keep investors from pricing in an eventual rate hike”.
Author of the report, Tony Crescenzi, said investors need to focus on the “slow speed” and “low magnitude” of future rate increases when constructing portfolios.
Investors should consider “the outlook of rates around the world, rather than the timing of the Fed’s initial hike”, said Mr Crescenzi.
Moreover, investors should think long-term when factoring potential rate hikes into investment decisions, he added.
“In particular, the low interest rate environment will likely prevail for the rest of the decade, compelling investors to continue to reach for higher yields and returns,” he said.
“We suggest investors position themselves accordingly, favouring a bias toward overweighting credit and equity risk, taking advantage of opportunities to add to both if anxieties creep into markets, as they so often do.
“Favour also an underweight to US duration, a bias toward a flatter yield curve, as well as a stronger US dollar ahead of the Fed’s rate hike cycle,” Mr Crescenzi said.
In response to inevitable rate hikes, Pimco expects market volatility.
“We expect markets to become even more volatile when the anxieties inevitably grow in response to the imminence of a Fed rate hike, creating risks but also opportunities.
“We suggest investors be prepared to act when opportunities inevitably rise,” Mr Crescenzi said.
According to Pimco, the Fed is concerned that if it raises rates “prematurely”, there will be an exit of investors who have “ventured ever outward along the risk spectrum”.
“To manage the risk of a rate spike, as well as to safeguard the substantial progress seen on the economic front, the Fed these days is taking no chances,” Mr Crescenzi said in the report.
“[The Fed] is working exhaustively to convince investors to continue doing what they have done in recent years and in fact for centuries, which is to take a leap of faith and stay invested in hopes of making profit, chiefly by aiming to convince investors it will move cautiously on rates,” he said.
“The Fed is losing its grip – be alert and prepared to catch what moves,” Mr Crescenzi said.