Losing patience: Has the market overreacted to Fed interest rate shift?

While the UK was waiting for Chancellor George Osborne to give his much-anticipated Budget speech, in the US the Federal Reserve was deciding on its next move on interest rates.

The US Central bank surprised the markets when it dropped its commitment to be “patient” when considering interest rate increases, while also signalling it is in “no rush” to raise rates. This caused a rally in both US stocks and bonds, as well as a 3 per cent drop in the value of the dollar against the euro.

US interest rates have been kept at record low of 0 per cent since the financial crises in 2008.

Given the uncertain timing of the Fed’s next move, investment managers are anticipating periods of volatility in the coming months. But, has the market overreacted to the Fed’s announcement?

Axa Wealth head of investing Adrian Lowcock thinks Fed chief Janet Yellen doesn’t necessarily want to raise interest rates rapidly in the short-term, as she wants to see wage inflation rise first.

He says: “If you can get to a point when you get sustainable wage growth inflation, that increases productivity which is good for the economy and for stockmarkets in the longer run.”

Russell Investments associate portfolio manager Rory McPherson argues the market has overreacted to a “moderately positive” outlook from the US central bank. He thinks the US economy will grow 3 per cent this year and expects the bank base rate will increase gradually.

JP Morgan Asset Management lobal market analyst David Stubbs says the Fed’s outlook on the country’s employment capacity was more significant than its adjusted statement on interest rates. Policymakers have dropped their estimate of the economy’s “full employment” level from an unemployment rate between 5.2 per cent and 5.5 per cent, to a range between 5 per cent and 5.2 per cent.

Stubbs says: “This is a group of policymakers who are now happy to let the expansion run. I think they are not going to raise interest rates in June, I think it’ll be September and it is a good thing.”

Tilney Bestinvest managing director Jason Hollands thinks there is still a chance of rate rises both in the US and the UK by the end of this year.

But the combination of the latest guidance on the US and low inflation is taking some of the pressure off, he says.

Lowcock says low productivity growth is a key risk facing the American economy. “We see a slip in productivity in America and that’s quite critical. The dollar is strong and they need to be more productive to be able to compete globally.”

However the biggest threat facing the country is the strength of the dollar, according to Lowcock.

He says: “The strong dollar against the weak euro makes the European companies still relatively attractive compared to their more expensive US peers.”

Despite the “very challenging environment” Lowcock still sees investment opportunities. He says: “You have still got corporate earnings growth and cash rich companies. There is going to be an increasing domestic focus until the US dollar gets stronger.”

Lowcock argues cash rich companies across the Atlantic are increasingly looking at share buy-backs, which tend to boost share prices, as well as mergers and acquisitions. 

However, US fixed income face headwinds including the strength of the dollar, low inflation and weak global growth, according to Neuberger Berman portfolio manager for Global Investment Grade Fixed Income Thomas Marthaler.

McPherson says Japan and Europe offer better value for investors than the US and predicts “double digit growth” for both equity markets. In his portfolio McPherson is overweight Japan and European equities at 3 per cent and 8 per cent, respectively.

Tilney Bestinvest has recently taken off some of the bullish positioning on the dollar in his portfolio. The group has been long the dollar through an exchange traded fund held in their managed fund of funds since early March.

“We took this position as we had the view that the dollar would be stronger and the main change that we made was to sell this holding on 12 March to lock in a profit ahead of the Federal Open Mark Committee meeting,” explains investment manager Marcel Porcheron. 


The strengthening of the dollar has also added pressure on some of the emerging markets.

“Brazil, for example, has priced in dollared borrowings and that has placed a lot of pressure on the country,” says Stubbs.

Stubbs is much more positive on US equities than his peers as he thinks the bull market in the dollar will resume. He is convinced the asset class is going to be supported by a “healthy economy”. “Bonds should not take too much of a hit because interest rates are not going to rise that quickly so it is a good moment for both asset classes,” he adds. 

With the economic cycle moving forward, consumers will invest more and that will help technology, material and industrial stocks, Stubbs argues.

He says: “It is hard to find overweights and underweights in this environment. I would advise investors to put their money with a fund manager with a good investment philosophy but maintaining exposure.”

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