Risk Management Conference 2022: Tactical Fixed Income Strategies for Managing Risk in Volatile Times
The key to understanding the US Federal Reserve’s responses to inflation is to think like its chairman, Jerome Powell, rather than looking at its forecasts and reports on the consumer price index, he noted. . “Whenever we come to a monthly CPI, realize the market will be waiting for – period – that number. But there are two numbers to pay attention to right now, the CPI and employment.
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Moore said bond investors gain a cross-sector perspective by considering employment numbers. “You’re probably going to have some beta rotation in your portfolio, so you’re going to want to get a sense of interest rate sensitivity and where the debt markets might go, and what’s going on with that. the different types of risky assets. That’s also a great way to look at it to start with, because that’s what President Powell is focusing on. . . . I call the ‘now casting’ approach .
Contrary to expectations, this double-digit approach offers key insights into how quickly the Fed will shrink its balance sheet as quantitative easing ends, he added, suggesting other approaches could overestimate sentiment. central bank emergency. “The balance sheet is going to stay a lot bigger than you think for a lot longer. I don’t think they have any idea how they’re going to bring it down in a big way.
To back that up, Moore pointed to the huge number of mortgages bought by the Fed in the aftermath of the pandemic — an increase that left nearly one in three American homeowners directly indebted to it. “They’re probably going to keep that high, even though the Fed has given up on buying new ones at auction.”
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For institutional investors, the Fed’s lackadaisical approach to shrinking its balance sheets should encourage an increased focus on interest rate sensitivity to hedge against volatility, he said. “If you look back over the last 10 years, the average daily movement of a 10-year Treasury note was three to four basis points. Now it’s going to be eight to 10. . . . What’s interesting is that is that that’s really what daily rate volatility was in the 1990s so it’s not unprecedented it’s just that we’ve really gotten used to rate repression and a very central bank authoritarian.
Another weapon he suggested bond investors keep in their arsenal during times of high volatility is the Merrill Lynch Option Volatility Estimate Index. “If you’re going to do something tactical and you’re going to try to get more of your base allocation or more absolute returns, the first thing you need to realize is that every market has its nature. In it, the rate volatility is higher and the way to see this is the MOVE index.
Scouring the MOVE Index, Moore said his team analyzed a dozen bond markets with significant investor interest. In several cases, the Fidelity team found reason to question popular sentiment, particularly regarding emerging markets. “EM is either first or worst in your portfolio, there is no middle ground. It looks like stocks, but with a third of the yield, so it’s hard to allocate big chunks to it. . . . The more you put into it, the more unstable your beta is at the base level.
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Up close, the other 12 bond markets also present a bewildering mix of pros and cons, he said. “You see generally positive returns. There are negatives in 2013, 2015 and 2018 – but not all. This market may seem unique, but it is not really unique. It’s a huge Fed cycle that walks and talks like 2000, only with 50% more beta. »
Rather than focusing on individual bond markets, Moore advised investors to take inspiration from the broader bond market. “If you’re the chief investment officer of a large pension, you love stable beta. Allocations have a good degree of certainty as to how they will act in a portfolio. . . . So when we build our portfolio, we decided to focus only on the aggregate. We don’t want to own what’s in the [bond aggregate index]we just want to wiggle the same way and have the same tails.
Even in a high-yield environment, he said institutional investors can benefit from building a diversified bond portfolio. “One of the reasons people like bonds is that there’s usually a positive return somewhere, even if you think rates are going up. In the US you could probably do something in euros hedged against the dollar. »
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