Jon Mawby and Andy Li, managers of GLG’s Strategic Bond strategy, believe any interest rate rise from the US Federal Reserve this year could turn out to be a significant policy error.
Improving headline data in the US is putting the Federal Reserve under increasing pressure to bring an end to accommodative policy and raise rates later this year.
While the actual rate rise is likely to be marginal, Mawby and Li believe the language the Fed uses in any accompanying statement risks confusing investors, causing a spike in volatility which will hit many asset classes.
“Now the European Central Bank has taken on the baton of quantitative easing from the US, we think the Fed will raise rates this year, and we think this could be a significant source of volatility across asset classes,” Mawby said.
“It will not be the actual move to raise rates that causes a problem but rather the language used by the Fed, which could be worded poorly. Thus, rather than provide comfort for investors it could create a lot of interest rate volatility.”
While Mawby and Li are concerned about the implications of a policy swing in the US, they do not expect the Bank of England to mimic the Fed this year.
“The problem facing all central bankers – and in particular those in the UK – is that while readings such as unemployment are allegedly improving, the quality of that employment is very poor,” he said.
“The jobs being created are of a lower quality – with more part-time roles being counted in the overall figure – and if you look at real wages, although recently improved, they remain subdued even in the light of lower inflation. Until that is tackled, the recovery in the UK is just too fragile to start raising rates.”
Mawby and Li are also becoming more cautious on the overall environment for fixed income markets as both credit and interest rate risks have converged.
With low yields on core government bonds – and indeed negative yields in the case of Switzerland and some other regions – Mawby said if we start to see a move upwards in volatility, it could lead to increasing instability for asset class correlations.
As such, the duo are looking at alternative ways to protect against potential losses should correlations between traditionally risk free and risky assets increase.