Defend and attack

clock • 10 min read

Chris Iggo (pictured) is CIO Fixed Income at AXA Investment Managers.

The Federal Reserve (Fed) may not hike rates this week but financial conditions are easier today than they were in December at the time of the first move.

Unless there is more evidence that the US economy is slowing down, markets will have to price in some increases in rates after June.

However, the Fed is going to take it slow and steady and the outlook is not that damaging for bond investors. Indeed, with the benchmark of cash being zero or negative, our view is that bonds are still attractive.

If you need yield and are worried about risk, short duration strategies are an attractive way of getting exposure to bond market income.

Yes, there are longer term concerns about returns, but in the short term with confidence in the global economy still weak, fixed income can’t be ignored.
Pass or play?

Regular readers will know that a few weeks ago I expressed the view that the US Federal Reserve would opt to raise interest rates again in June.

That view was backed by numerous comments from Fed officials suggesting that conditions were appropriate for another very small increase in the Fed Funds rate.

However, last week’s employment report for May put the skids under that view and it now seems that there is a strong chance that the Fed will pass in June.

I can’t, for the life of me, believe that serious central bankers think a rate hike a month apart makes a huge difference to how the economy will operate over the next couple of years, but the view now seems to be that an increase in July could be seen.

Employment expanded by only 38,000 in May and this was taken by the markets as a signal to bet that June is off the cards.

I was once told by a senior official at the US Treasury in Washington that they didn’t really pay too much attention to any individual monthly non-farm payroll headline jobs number given the “white noise” or margin of error was estimated to be as much as 200,000 per month.

Given that the unemployment rate fell to its lowest recorded level since November 2007 and hourly earnings growth remained at an annual rate of 2.5%, there is little evidence that the economy is rolling over.

I have some sympathy with the view that the closer you get to full employment the more difficult it is to create new jobs.

There are just not enough skilled available workers, especially when the participation rate in the labour market has fallen for structural and other reasons in recent years.

I might be wrong and the 38,000 increase in employment might be the first sign of the economy going into a downturn, in which case the Fed won’t be raising rates in July or September or at any time in the foreseeable future.

But I don’t believe that is the case. If the former explanation is the right one, then wage growth should continue to pick up from current levels.

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