‘It feels a lot like we are back in 2010’

On Monday US Federal Reserve member Lael Brainard took a dovish tone and cautioned against raising rates in the US too quickly.

According to RMB Global Markets, the probability of the Fed hiking next week is now around 15%, with the probability of a December increase at 55%.

Over the last few years market participants have become almost obsessed with the Fed’s thinking around the timing and intensity of interest rate hikes as a lower for longer scenario is generally perceived as good news for equity markets.

Cai Rees, director at Nasdaq-listed SEI Investments, says a rate hike is unlikely to happen at all this year.

“If it were to happen, they will just about be able to sneak one in in December.”

Central Bankers tend to be fairly conservative. The Fed in particular tends to prepare markets for a rate hike, and when markets overreact just as it is about to happen, it postpones.

“That could happen again. That has happened plenty of times in the last handful of years [and] that could happen again in December,” he says.

There is also the US general election in November to consider.

“I can’t see them raising before the election and there is only one realistic slot afterwards and that is December,” he says.

December used to be a “non-hike month”, but the Fed did hike rates in December last year.

If Hillary Clinton becomes president and markets don’t react negatively, there is likely to be a hike in December.

“If Trump gets in, then probably not. So there are some critical events which sort of determine in our point of view whether they can squeeze that one in into December,” Rees says.

While a Trump presidency seemed highly unlikely not that long ago, it is now a very real possibility.

“We saw it in the United Kingdom, with the vote to leave the European Union,” he says.

And this was despite governments and institutions such as the World Bank and Central Banks arguing for Britain to remain.

“We’re seeing rises of populism in political parties in Italy, in the Netherlands, in France, we’ve seen [German chancellor] Angela Merkel lose a lot of support in Germany and we’ve seen Donald Trump achieve the nomination, which didn’t look likely before.”

There seems to be this political movement where audiences are ready to listen to a type of anti-establishment vote, he says.

“Our base case is that Hillary Clinton would win, and that a rate rise in December would be possible, but really we are just talking about one here. We are talking about maybe one.”

Rees says it is probably fair to argue that the Fed is now more “international” in its consideration. While its mandate previously revolved around the US economy (inflation and jobs) it has suspended rate rises on emerging market fears, the so-called “taper tantrum”, the Brexit vote and general market turmoil after China devalued its currency, while all along US job numbers were fairly good and the economy was doing well.

What it means for markets

Rees says there is still potential that markets could continue to rally in years to come.

“It feels a lot like we are back in 2010, where bad news is good news, because bad news is QE [quantitative easing] and QE is good news. We are seeing lower [interest rates] for longer. We are seeing Central Bank intervention and we are seeing more exotic forms of Central Bank intervention.

“So there are plenty of reasons to believe that from here asset prices can sort of sustain themselves to an extent. We are not expecting big rises, but we are expecting that people move up that risk spectrum, so from government bonds to corporate bonds, from corporate bonds to high yield, from high yield to defensive equities, and then eventually – we haven’t seen this part yet – but from defensive equities into cyclical equities.”

SEI is positioning itself for the last piece – rotating out of defensive equities into growth cyclical equities.

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