Fed Catch-Up to Market Pricing Has Street Standing Firm on Calls

A hawkish surprise from the Federal Reserve may have jolted financial markets, but it’s not enough to dislodge strategists from their conviction calls.

Many say officials are merely catching up with market pricing and are holding firm with forecasts for a gradual rise in yields. Strategists still expect a step-by-step process toward trimming asset purchases and then bringing rates up from zero -- so they’re reluctant to tear up their assessments, even though the shift is rippling across global markets, driving Treasury yields higher and weighing on stocks.

Few see a major turning point, even after the Fed brought forward forecasts for expected interest-rate hikes, provoking the dollar’s sharpest rally in a year. Here’s a collection of their views:

Gradual Yield Rise

J.P. Morgan Asset Management global market strategist Kerry Craig:

“We expect yields to continue to rise over the course of this year in a relatively gradual manner. Given the lower starting point on yields today than a few months ago, this limits their attractiveness and reinforces a modest short duration in portfolios.”

Columbia Threadneedle portfolio strategist Ed Al-Hussainy:

“I think about what it would take to get the 10-year sustainably above 2% and I suspect we will need another fiscal push. The Fed alone will struggle to do it.”

PGIM Fixed Income lead G10 economist Ellen Gaske and chief investment strategist Robert Tipp

“Given the upward surprise in growth and inflation numbers resulting from the Covid recovery and powerful fiscal stimulus, the Fed’s pulling forward of its expected timing for rate hikes seems fitting. But in terms of the market outlook going forward, we continue to think that rates are likely to peak around mid-year -- if they haven’t peaked already -- as they price in the recovery and the prospects for Fed normalization.”

Dollar Support

Goldman Sachs Group Inc. strategists including Zach Pandl:

“We continue to forecast broad U.S. dollar weakness, driven by the currency’s high valuation and a broadening global economic recovery. However, more hawkish Fed expectations and the ongoing tapering debate look likely to be a headwind to dollar shorts over the near term.”

TD Securities strategists including Priya Misra:

“The Fed’s super hawkish pivot should reinforce the lows and offer further near-term dollar support. A double-whammy of higher rates and wobbly risk sentiment would result in positioning squeeze and the start of a new narrative. A possible replay of the 1Q dollar move would imply around a 2% broad dollar rally through the summer months.”

Deutsche Bank AG chief international strategist Alan Ruskin:

The magnitude of the dollar follow-through will be governed by the extent to which both a taper and the timing of short-term rate expectations change, such that the Fed is not seen as “behind the curve.” It will also depend on whether the back-end also responds or remains suppressed. The risk now certainly lies to dollar topside, with a break of $1.1986 on the euro targeting $1.1717.

Reset Expectations

Principal Global Investors chief strategist Seema Shah:

“Now it will be up to Powell and other Fed speakers to once again reassure markets that tightening in 2023 doesn’t need to be disruptive. There will still be question marks about the timing of tapering but, overall, the dot plot shouldn’t unnerve the market too much, as long as Powell gets his communication on target.”

Harris Financial Group managing partner Jamie Cox:

“The Fed is in uncharted territory and is playing both sides: sticking with their transitory narrative but addressing inflationary pressures. Markets will need a few days to digest this information before settling out.”

Credit Undaunted

Mizuho Securities Asia head of fixed-income research Mark Reade:

“While the FOMC meeting was more hawkish-than-expected, it was ultimately all talk and no action. With tapering of asset purchases ‘still a ways off’ and rate hikes even further in the distance, front-end rates should remain capped and the Treasury curve steep. Against that supportive backdrop, we expect the grind tighter in USD credit spreads to continue.”

Emerging Weakness

TD Securities strategists:

“A mix of higher U.S. rates, a firmer dollar, and wobbly risk sentiment could reverse some recent gains in emerging market FX, especially in Latam and CEMA.”

BNP Paribas Asset Management senior portfolio manager for emerging market debt Ek Pon Tay:

“A taper announcement is likely imminent, which I expect to be marginally negative for credit spreads. Spreads should reprice wider, particularly in Asia investment grade, where the spread cushion isn’t all that generous to offset central bank support being potentially withdrawn. We advise investors to reduce portfolio net duration sensitivity and allocate away from the front end and belly to long dated Asia credit spreads, which we expect to relatively outperform from here.”

Asia Plays

Global CIO Office chief executive officer Gary Dugan:

“Japanese equities could benefit as a stronger dollar helps the competitiveness of Japanese exporters. China’s asset markets are unlikely to react as the stronger dollar helps exports and the U.S. monetary policy now seeming on an earlier path to tightening would make China’s recent tightening not so out of whack with the rest of the world.”

TD Securities EM Asia and Europe strategist Mitul Kotecha:

“Asian currencies are likely to take a hit today in the wake of the Fed outcome, with more rate sensitive currencies such as SGD, KRW and CNY likely to face relatively more pressure though we expect most Asian FX to trade on the back foot.”

Stock Rotation

Jun Rong Yeap, market strategist at IG Asia Pte.

”The hawkish signal may benefit the financials as seen from the resilience in its performance overnight. But looking beyond that, the upward revision in GDP forecasts and the rise in yields may potentially drive investors to rotate back into cyclicals and recovery sectors.”

Ilya Spivak, head Asia Pacific strategist at DailyFX

“If it begins to look like the Fed is behind the ball and may need to move to tighten meaningfully faster, broad-based risk aversion that is negative for equities in general might be in the cards.”

Spillover Contained

BlackRock chief investment officer Rick Rieder:

“We don’t think that tapering the QE program will create tangible stress to the economy or markets, and in fact think that the biggest risk today would be an overheating paradigm where it’s hard to predict how high input, or wage, costs could get.”

“Markets are likely to adjust accordingly in some areas, such as extremely distorted real rates across much of the yield curve, but we believe the markets will ultimately cheer a return to normalcy.”

©2021 Bloomberg L.P.

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