Investment - Articles - LGIM cautions over ‘step into the unknown'

 Anton Eser said:

 “Two years ago, markets were unsettled by the potential of the Federal Reserve imminently tapering its QE programme. During this taper tantrum, bond yields rose, equity markets corrected and high-beta credit markets such as high yield and emerging markets saw heavy fund outflows and sharp price falls.

  

 “Today the stakes are much higher as the market steps into the unknown, turning its attention to the Fed’s first rate hike since 2006. Long-term structural problems associated with LGIM’s 4Ds – debt, deficits, demographics and deflation – have not be resolved by years of easy liquidity, and vulnerabilities associated with the 4Ds could reveal themselves as interest rates go up.

  

 “There is a worry that only a handful of rate hikes will be enough to slow the economy to such an extent that the Fed pauses and even considers reversing policy. Indeed, given our long-term growth concerns, a fourth round of QE is quite possible in the coming years. So short-term interest rates may rise as the Fed hikes, but longer-term yields will be suppressed by long-term economic prospects.

  

 “Even if yields do not move substantially higher, the 2013 taper tantrum demonstrated that such volatility can lead to fund outflows and wider credit spreads, leading to a period of negative total returns. Therefore investment grade credit markets have a backdrop of higher interest rate volatility with significant tail risks across emerging markets and Europe. We want to be in a position to take advantage of such a scenario with plenty of dry powder in the portfolios”.