Analysis-Nerve-racking week leaves bond investors calling for fast rate hikes
2022.06.20 10:06
FILE PHOTO: The Federal Reserve building is pictured in Washington, D.C., U.S., August 22, 2018. REUTERS/Chris Wattie
By Davide Barbuscia and David Randall
NEW YORK (Reuters) – A series of surprise actions by some of the world’s largest central banks fretting about runaway inflation has left bond investors battered. Now, a growing chorus of investors is calling on policymakers to move fast to end the uncertainty.
Until central banks are able to bring down inflation, some investors said, markets will not have any certainty about rates. Their best way forward may be to get to neutral interest rates — the level at which monetary policy is neither stimulating nor restricting the economy — as fast as they can, the investors said.
“We’re seeing these sort of rate hikes in an economy that is clearly slowing, and it creates this extraordinary uncertainty on how much will inflation come down and how much the Fed will have to go,” said Rick Rieder, chief investment officer of global fixed income at BlackRock (NYSE:BLK), the world’s largest asset manager.
“Sometimes the markets can take some time to adjust to it, but in the long run it’s a better way to go,” Rieder told Reuters in an interview.
Both DoubleLine Capital Chief Executive Jeffrey Gundlach and billionaire investor Bill Ackman in recent days also have called for higher rates by the Federal Reserve.
Central banks, especially the Federal Reserve, have faced criticism that they have acted too slowly in taming inflation. Investors said that has led to ugly surprises, such as the Fed’s larger-than-anticipated rate rise on Wednesday in the wake of the highest U.S. inflation reading in more than four decades.
“Playing catch-up is harder now as the central bank let … the first best policy response slip through its fingers” last year, said Mohamed El Erian, chief economic adviser at Allianz (ETR:ALVG) and chair of Gramercy Fund Management.
Fed Chair Jerome Powell said last week that the U.S. central bank’s target was to bring inflation down without a sharp slowdown in economic growth or a steep rise in unemployment, acknowledging that the path was becoming more challenging.
MARKET HAVOC
The Federal Reserve hiked rates on Wednesday by 75 basis points – its biggest raise in nearly three decades – and committed to delivering more big moves. Central banks across Europe also raised rates, in some cases by amounts that shocked the markets.
The moves wreaked havoc in bond markets, already in the throes of their worst start to a year in history.
Ahead of the Fed’s hike, two-year Treasuries hit their highest yield since the 2008 global financial crisis and benchmark 10-year yields – an important barometer for mortgage rates and other financial instruments – climbed to their highest level in over a decade.
In Europe, Germany’s 10-year Bund yield hit an eight-year high, at 1.93%, last week. In Switzerland, 10-year yields were set to end the week almost 50 basis points higher and set for their biggest weekly surge since March 2020.
Higher prices are bruising consumers by eroding savings while higher rates increase borrowing costs. U.S. housing finance giant Freddie Mac (OTC:FMCC) said last week the average contract rate on a 30-year fixed-rate mortgage rose by more than half a percentage point to 5.78%, the greatest one-week jump in 35 years.
Bond prices also swung violently in the opposite direction after the Fed hiked rates, with two-year and 10-year Treasury yields reversing their selloff by magnitudes not seen since 2008 and early 2020, respectively.
“In order for markets to stabilize and prices to rally … we need to see some degree of evidence that inflation has peaked and moving back down,” said Mark Dowding, chief investment officer at BlueBay Asset Management in London. “That is almost a pre-condition for the bear market to come to an end, and that will only happen in bonds first and then equities.”
That is easier said than done. Inflation is a poorly understood phenomenon. The market has not dealt with a regime of rising prices in decades.
“There was a view that a lot of this inflation was one-time in nature, was going to go away quickly, and that proved to be incorrect,” said Pramod Atluri, fixed-income portfolio manager at Capital Group.
Central banks are trying to control price pressures with monetary policies that curb demand, but they have little control over supply-driven factors.
“They are now acknowledging that fighting inflation – when it’s partly supply-driven and the only tools the Fed has are to cool demand – is going to come at a cost of somewhat slower growth,” said Allison Boxer, an economist at PIMCO.
‘PRONE TO ACCIDENTS’
For bond investors, the scramble by central banks playing catch-up has been devastating.
The Fed had told investors it expected to raise rates by 50 basis points at its June meeting. But right before the meeting, inflation data came in higher than expected.
Ryan O’Malley, portfolio manager at Sage Advisory, said policymakers were caught off guard by the latest inflation reading. For Steve Bartolini, a portfolio manager at T. Rowe Price, the data seemed to confirm that the Fed’s rate-hike cycle of increasing in 50 basis point increments – in line with previous guidance – would extend through November.
A Wall Street Journal story that appeared to leak the Fed’s intentions to move up by 75 basis points the day before the start of its two-day policy meeting was not enough to sway his belief in the measured path that Powell seemed to lay out at the prior meeting.
“I did not think they were ready to make the leap to 75 because they told us they weren’t going to make that leap,” Bartolini said, adding the Fed’s move has now significantly increased the chances of a recession and makes taking risk less attractive.
“As you are hiking rates at a time when growth is slowing it means that you’re prone to accidents” and the likelihood that the Fed over-tightens, he said.
