This Wall Street Veteran's Fear Is the Fed Hiking Sooner Than Expected
(Bloomberg) -- Like everyone on Wall Street, four-decade market veteran Bob Michele is on guard for the kind of inflation bogeyman that would force the Federal Reserve to hike sooner than expected.
The chief investment officer at J.P. Morgan Asset Management is watching out for a scenario where all manner of price pressures from supply-side bottlenecks to wage growth spur an interest-rate hike as soon as next September.
It’s not his base case just yet -- the money manager still has mid-2023 in his sights. But as this week’s bond selloff drives Treasury yields to the highest in three months, market fears are growing that inflation will prove far from transitory.
Michele, who oversees $17 billion of global bond portfolios, isn’t leaving anything to chance. He’s underweighting positions on bond duration on interest-rate risk while overweighting those of securities tied to floating-rate benchmarks, including leveraged loans and securitized credit.
“Six months ago, the risk was that the Fed will be slower to raise rates,” Michele said in a telephone interview. “But now the risk is that they would be quicker to hike if the inflationary pressure proves to be more persistent than they had thought.”
The Fed’s plans to pare stimulus from as early as next month is sending ripples through the world’s biggest bond market. U.S. 10-year yields rose as much as five basis points to 1.57% in early Wednesday trading, while 30-year yields jumped the same amount to 2.15%. The 10-year breakeven rate, a gauge of expectations of consumer prices derived from the difference in yield between Treasuries and inflation-linked securities, increased to 2.51%, the highest since May.
A spreading energy crunch complicates the path to tighter policy, while Fed officials have stressed that the issue of hiking rates is decoupled from tapering policy -- with a high bar for the former. Economists polled by Bloomberg expect the central bank to hold rates near zero through 2022 before delivering two quarter-point increases in 2023 and three more the year after.
The wildcard: The ever-tightening labor market.
“When you hear that workers will only return for much higher wages, and that companies have or intend to pass on higher input costs to consumers, you realize inflation is going to be stickier than the central banks are admitting,” Michele said.
He now expects benchmark Treasury yields will continue their ascent toward 1.875% this year. He famously rode the bull run in U.S. bonds, predicting in 2019 that yields were “headed to zero” when the 10-year benchmark was still trading at 2%. He reaped the rewards as the benchmark fell all the way to 0.5% within a year.
In the middle of the year he pivoted to take a bearish stance on duration exposure. Around the same time he pared holdings of emerging market debt, which face risks of contagion from China’s slowdown and are less able to cope with waves of virus variants with a lower rate of vaccination.
On the other hand, Michele has been a fan of U.S. junk bonds all year. The trade is paying off with the asset class posting the best 2021 performance of major Bloomberg fixed-income indexes, gaining 4.4% versus a 2.6% loss for Treasuries.
Drawing on a recent swim in a New Hampshire lake, Michele is telling clients to hold their nerve, with this week’s market action showing the risks to come as the Fed pares stimulus.
“After decades out of the pool, it’s all about doing the prep work and not panicking half-way through,” he said. “Investing is pretty much the same: do all the research and have a plan, and then don’t panic when the markets are volatile.”
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