Wall Street is so convinced that the Federal Reserve’s restrictive policies are nearing an end that money managers are already trading as if rate hikes were a thing of the past.
JPMorgan Asset Management is plowing into equities and at least one Invesco fund has done an about-face from its previous cautious positioning. DataTrek says investors are now betting on individual stocks instead of trading on macro themes.
Traders and economists are in near-unanimous agreement that the Fed will raise rates by a quarter percentage point Wednesday. Views diverge on how long the central bank will keep rates high and if another hike by the end of the year will be necessary. But one narrative is clear: The disinflationary process is underway, which means the jumbo rate hikes and volatility that came with them are firmly in the past.
“The market has now fully digested that plus or minus 25 basis points, the hiking cycle is coming to an end,” said Alessio de Longis, senior portfolio manager of the $1.1 billion Invesco Global Allocation Fund and head of investments for Invesco Investment Solutions. “In this regard, more surprises, more catalysts for volatility are going to come from the European Central Bank or the Bank of England, where I think rate hikes have more to go, not from the Fed.”
Options traders expect the S&P 500’s trading range from Monday through the end of the Federal Open Market Committee meeting Wednesday to be the tightest since November 2021, according to Citi’s Stuart Kaiser. This signals the market has more clarity about the Fed’s decision as economic data stabilizes, he said.
De Longis is moving away from the hard risk-off stance he held in March to embrace high-yield and emerging-markets debt, while reducing his exposure to safe havens like government bonds. He’s also scooping up small-and-mid cap stocks on a view that a recession won’t emerge until the second half of 2024 and the US central bank has only one or two more rate hikes to go.
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A recession seems less likely even to Phil Camporeale, portfolio manager of multi-asset solutions at JPMorgan Asset Management, who’s now overweight stocks and is opting for duration within bonds. The end of the Fed’s cycle of rate increases will be a boon for stock-bond portfolios that were crushed as the central bank relentlessly raised rates last year, he said.
“If we didn’t think that the disinflationary process was occurring and the Fed was near the end, we wouldn’t be able to take this much risk because we wouldn’t be confident in the defensive characteristics of bonds,” he said.
With rate volatility expected to drop, bonds can resume their traditional role of providing diversification within portfolios, Camporeale said.
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Burned Before
The recent bout of confidence about the Fed’s path ahead comes after Wall Street has been burned by wrong-way bets about the central bank a few times since last year. The Fed has continued to say that they are keeping rates higher for longer, even as markets are pricing in cuts as early as December 2023. Central-bank officials have also suggested that slowing inflation to their 2% target will require more work, even though some bond-market bets see that happening soon.
The Fed may need to continue intervening if long-term dynamics such as a shrinking labor force and a transition to green energy keep prices higher across the globe, according to Adam Farstrup, head of multi-asset, Americas at Schroders. While in the near-term he says it’s clear that Fed policy has somewhat slowed inflation, he’s taking a more cautious stance by being neutral on equities as the macroeconomic backdrop in the US remains complicated.
“One of the outcomes of this inflation pressure that we see is much more frequent market-driven rate cycles,” he said. “Central banks are now back in this game of having to respond much more quickly to inflation pressures because we’re no longer on the edge of the deflation cliff.”
Despite some investors’ wariness, Nicholas Colas, co-founder of DataTrek Research says that overall, the market isn’t worried anymore about what the Fed will do. S&P 500 sector correlations are running below five-year averages, indicating that traders are making stock-specific bets, he said.
The equity rally has spread out to economically sensitive names, Colas added. And stock volatility has dropped as well, with the Cboe VIX Index — also known as Wall Street’s fear gauge — running well below its long-term average of 20.
“Fed policy and the risks of an overshoot were the central drivers of US equity prices from January 2022 to May 2023,” Colas said in a mid-July note. “Now, markets believe we’re entering a ‘post-Fed’ world.”
