The suggestion US rates could rise as early as 2015 is the opening salvo in new Fed chair Janet Yellen’s efforts to keep investors’ feet fixed firmly to the floor.
That is the view of David Roberts, head of fixed income at asset management firm Kames Capital.
Roberts was speaking to Citywire Global in the wake of Yellen’s first FOMC meeting and press conference earlier this week, in which she cut bond buying by a further $10 billion a month and said interest rates could rise six months after the QE programme is fully finished.
‘Whether she has done this wittingly or unwittingly is a different question, but what Yellen did do is kick investors into the mindset that rates will have to rise, particularly at the short end of the curve,’ he said. ‘It was a move to combat complacency.’
Although there is a danger of over-reading Yellen’s first meeting, Roberts said there was a definite benefit to her making a strong statement of intent from the outset.
‘We are in a situation where unemployment is coming down, meaning a huge amount of people are coming back to the labour force, which is coupled with signs of a housing recovery, and there is a subsequent wealth effect we can see.
‘With one eye on the next round of data, which could show the economy is going gangbusters, there is a good reason for Yellen to remind investors that rates could go higher.’
Playing a rates rise
Roberts, and co-manager Philip Milburn, have previously approached the US situation through a tactical play on the US yield curve, which involved shorting five year treasuries while holding 30-year dated bonds.
This, Roberts said, remains an effective tactic with the spectre of a rates rise on the cards. The pair expect mid-range bonds, such as the five-year treasuries, to be the most vulnerable to volatility in a rising-rates environment.
‘We have been adopting this curve-flattener approach, where we are short the five-year, and we did take a bit of profit after Yellen’s comments. The idea is by holding the short and the long end, we are effectively getting the curve close to zero.
‘We have about 1.9% more in 30 years than five years, and we expect that to be the case over the next 18 months. If we see rates rise towards around 4% then the differential effect is going to disappear but we will make use of the relative underperformance.’
The Kames Strategic Bond Acc A fund returned 95.4% over the five years to the end of February 2014. This compares with a rise of 76% by its Citywire benchmark, the LCI iBX GBP Cor/Citi WGBU/,L HY/FT Bri Gvt A stk 7, over the same period.