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A bumpy end of year

  • Risk Manager
  • Blog post submitted on 18th December 2015

The Federal Reserve’s last monetary meeting of this year passed without any surprises but even so, the first rate hike since the 2007-crisis and the comforting tone of Fed’s Yellen was enough to support a short relief rally. Much has been written about the significance and implications of this moment and, more importantly, about how different this incipient interest hiking cycle will be from the previous ones. That is, to market’s comfort, there is a wide consensus among analysts and investors alike that the Fed will not have reasons to increase the key rate as much as it did in the past. So far, this has kept longer term rates at bay and has given investors a reason to look for yield elsewhere and, hence, take more risk.

Having said this, the transition is due to be bumpy as markets have to adjust to a new monetary policy mode which seems poised to become driven more by qualitative assessments. As it was the case over the past few months, this is not without risks as it complicates the predictability of the interest rate path and can be a source of market volatility. On top of this, some market participants are worried that the end of the current economic cycle might be so close that it will find Fed without sufficient ammunition. Better said, there are concerns that the slowdown will take hold of the US economy at a time when interest rates will still be low and that reducing rates will have to be (again) complemented by non-traditional measures.

As such, thoughts continue to be aired by various analysts and large investors, it should come as no surprise that the risky assets are taking some steps back from time to time. The end of year trading conditions, the defying fall in crude oil and concerning headlines regarding the high yield bond market are also taking a toll on sentiment at times. To put it differently, my impression is that investors are finding buckets of attractive valuations in equities and bonds but a series of downside risks continue to delay a decisive trend reversal.

Stopping for a moment at the high yield bond market, this month was marked by talks about low liquidity and potential damaging (or even unsustainable effects) on US mutual bond funds which have been faced with redemptions in the aftermath of the oil weakness. Although there is no denying in the fact that bond markets have been left with lower liquidity post-crisis (partly due to regulatory changes which resulted in banks downscaling their trading function), it is also true that the recent correction has pushed yields and spreads to multi-year highs. Indeed, in the US market the latter are higher than it was the norm in the past when the Fed embarked on hiking rates and some calculations are showing that at these levels they are pricing-in recession-like default rates. It is as well worth noting that although the USD high yield indices have lost around 5% this year, a look at the sectorial breakdown shows that this is largely reflective of the weak performance posted by energy, basic materials and telecoms.

Overall, there is evidence that investors are still not convinced how much risk they are willing to take on over the remaining trading sessions of the year; amid December-like liquidity this is naturally resulting at times in jerky price movements which are seen by some as opportunities. Both long-term value and short term opportunistic investors might hence find this end of year to be to their liking.

Have a nice day!


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