17th September 2015
Market returns tend to be positive and volatility low when the US Federal Reserve (Fed) starts to raise interest rates, according to analysis of historical market data by Exchange Traded Product (ETP) provider Source.
This is contrary to widespread investor concerns that such periods of monetary tightening result in increased volatility and weak asset performance.
A review of USD-denominated average annualised total returns during previous Fed tightening cycles by Source shows that a broad range of asset classes have exhibited positive performance – for instance, Global Equities have returned around 10%, Emerging Market Equities 12% and Commodities 18%. According to Source, investors should therefore see a likely Fed rate rise as a positive reflection of the wider global economy and the strength of the US-led recovery.
|Average annualised returns, in USD, during previous Fed tightening cycles|
|Global Government Bonds||
|Global Corporate Bonds||
|Global High Yield||
|Emerging Markets Equities||
|Emerging Markets Government Bonds||
The firm believes that the Fed will start hiking rates soon in response to strong growth in the US and other key markets, notwithstanding the recent volatility seen in China, and to counter extremely loose central bank policies that have been fuelling the global economy.
The Fed has now kept rates at current historical lows since 2008. Taking into account the effects of Quantitative Easing (QE) and that each $150–200 billion of asset purchases is equivalent to a 25 basis points cut in Fed policy rates, the effective rate of interest in the US is currently -5%.
In terms of the world’s top 10 economies, the US and the UK are currently the strongest and will therefore be tightening monetary policy soon, believes Source – this it said is in contrast to markets such as Canada, China, Russia and Brazil, which are entering recessionary environments, and the Eurozone, Japan and India, which are showing signs of being in the early phases of recovery.
Paul Jackson, managing director, head of multi-asset research at Source, said: “It is just a question of time in our view before the Fed raises rates. While major economies are at different stages of the cycle, taken as a whole we see that a Fed hike is imminent – particularly given the unprecedented influence of a high, negative interest rate under the so called Bernanke rule of thumb from QE.”
Source’s further analysis of the previous six Fed tightening cycles shows that the tightening cycles lasted an average of 13.7 months and the average rate hike was 281 basis points (21 basis points per month). Source believes that the forthcoming cycle may be slower and longer given the relatively larger headwinds, and is forecasting 25 basis points per quarter over multiple years depending on the rate of inflation.
Jackson added: “Our research shows that since 1930 there were two periods of monetary tightening out of 16 where investors lost money on the S&P500. It is important, therefore, to counter misperceptions that a rate hike is somehow bad news for markets, including the belief that volatility tends to increase during such cycles.
“Our analysis shows that market returns during such periods of tightening have been positive and with lower volatility across a variety of asset classes and indices, and therefore a Fed rate rise should represent an opportunity for investors.”