Investors have been warned not to take any future interest rate cuts by the US Federal Reserve as a permanent situation.
Analysts and commentator are almost universal in their verdict that the Fed will cut after their next meeting on July 31 as an insurance policy against a weakening US economy.
Brian D’Costa, co-founder and president of Algonquin Capital, Toronto, told WP that the Fed is probably unsure whether they have raised too much and where the neutral rate is. But rather than popping the champagne and celebrating the welcome breathing room a cut or two will provide, D’Costa said investors should be wary of higher inflation and a return to the hiking policy that both the Fed and the BoC had been pushing.
He said: “The turnaround in equities and credit and risk assets that occurred in late December and has carried on into this year was largely tied to the Fed in that they indicated they were not going to hike further and, in fact, would be easing.
“I just think that investors should remember that just because the Fed might be easing over the next six months, nothing actually stops them going back to hiking in the future, if conditions warrant, because of higher inflation.
“Easing is not a permanent factor and so when the markets respond to the stimulus or promise that a stimulus is going to be removed, you are probably going to see an adverse reaction in the markets. So, you just have to be mindful of asset allocation and long-term goals and not get carried away with the short term.”
Central to this advice around rate cuts is the fact D’Costa believes fixed income is going to be a low-returning asset class for some time to come and, therefore, could lure investors out of their comfort zone and into higher risk.
He explained: “If we look at future returns out of fixed income, given where rates are, I would say that they will be uninteresting for investors, meaning that the yield on an investors’ portfolio, even if it includes some investor grade credit, is going to be something in the range of 2.5%.
“The only way to get a higher return would be if interest rates go lower, so you get some capital depreciation on that. We think that traditional, long-form fixed income investing is going to be a low-returning asset class for some time to come.
“The key for investors will be to be very cautious around the level of risk they feel compelled to take – i.e. having more duration or going into lower quality credit. That is going to take a fair amount of discipline for investors when thinking about the risks associated with moving further up the risk spectrum.”
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