Gertrude Chavez – Dyfuss, Davide Barbuscia

NEW YORK (Reuters). The Federal Reserve’s well publicized plan for raising interest rates by half a percent on Wednesday, and then starting to reduce its balance sheets has been unsuccessful in reducing inflation and growth fears. This has prompted bond investors to look to increase their safety margins by adjusting the length of their portfolios.

Asset managers stated that safety trades could be short- or long-term depending on perceived risks.

Fed funds futures track short-term rates expectations and have already priced in at least three increases of 50 basis points this year. There will be more than 250 cumulative rises.

The market had priced in a Fed funds rate of 2.6% by 2022 instead of the current 0.3%.

Fed will likely pull the two leg out of under the punchbowl by raising rates and allowing its almost $9 trillion balance to shrink by up to $95B per month beginning in June. It is an aggressive two-fisted strategy that’s never been tried with this much intensity.

Many bond investors kept short-duration fixed interest securities in their portfolios ahead of the Fed meeting. They do this to hedge against Fed tightening. Shorter-duration bonds perform better than longer-dated securities in an environment with rising rates.

Insight Investment has decided that it is better to remain neutral on duration risk than to continue to underweight the benchmark.

Jason Celente is a senior portfolio manager for Insight Investment. He stated, “There’s still quite a bit of uncertainty.”

Is inflation going to fall? The Fed will likely continue to run inflation hotter than in the past. It’s likely that this will take some time.

U.S. inflation and wage growth https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnyzjxvq/US%20inflation%20and%20wage%20growth.PNG

U.S. Treasuries fell sharply in 2022 as inflation expectations increased and Fed’s response to them drastically changed over the last few months. BofA U.S. Treasury Index (NYSE:) fell 8.2% in 2018, marking its worst year since 1997.

The shorter-duration ICE BofA 1-3 Year U.S Treasury Index did a bit better with only 2.7% losses so far in 2022, and 0.3% for April.

John Lynch (NYSE: Wealth Management chief investment officer) stated, “The simplest and most risk-free solution is to reduce or eliminate the duration risk.”

He mentioned money market fund yields which rose from zero to around 0.25%. They should rise further as the Fed tightens its belt.

Lynch also suggests ultra-short bond fund options. These funds have shorter maturities than one-year and deliver better returns than long-duration alternatives. Yields are rising to the 1.40% level.

PRICING AND RECESSION ISSUES

Others are also trying to hedge against the U.S. economic recession. This view was reinforced by the U.S. GDP contraction for the first quarter.

The data from Thursday indicated that the GDP fell by 1.4% in annualized terms during the first three months. nL2N2WP2ZV]

Peter Cramer (head of SLC Management’s insurance portfolio management) stated that “The Fed will struggle to achieve the number of increases that the market has priced-in.”

The market’s expectation of higher rates is already causing a lot of damage. We’re already starting to see a negative rate of GDP growth in the first quarter, even though the Fed only raised once.

Cramer also mentioned the U.S. 30-year interest rate of 5.37%, in week 22 April. This is the highest ever since 2009. It should be a stumbling block to housing demand. In February 2021, these rates were less than 3%.

The Fed should not raise rates aggressively, as he believes that the U.S. might enter recession in either late 2022/early 2023.

Cramer’s cry for recession echos that of Deutsche Bank (ETR:).

U.S. Smoothed Recession Probabilities https://graphics.reuters.com/USA-MARKETS/zgvomlzayvd/chart.png

Deutsche stated in a research paper that it expects the Fed funds rates to rise above 3.5% and 0.50% additional tightening via the Fed’s reduction of its balance sheets. Deutsche stated that this is sufficient to cause a slight recession in the U.S. by next year, and possibly for several years more. This should lead to inflation being at more desired levels.

Cramer of SLC said that with the U.S. recession looming, he is being defensive and has been long-term, especially in the 3-year portion.

Long duration is indicative of expectations U.S. yields would fall as the Fed reduces rates.

Cramer stated that his portfolio also has improved in credit quality, and moved away from credit sensitive sectors.

Robert Tipp, head global bonds, PGIM Fixed income, stated that there are times when it is a good idea to keep an aggressive interest rate.