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15 May 2015
Risky assets increasingly sensitive to Fed rate expectations – BAML
FXStreet (Barcelona) - Strategists at BofA-Merrill Lynch, explain that correlations imply that stock and credit markets tend to underperform when market expectations for a Fed rate hike turns hawkish, and vice versa.
Key Quotes
“Risky assets have become highly sensitive to Fed policy expectations recently. Although stock and bond returns are normally negatively correlated, the 3m correlation between daily returns on S&P and 2y UST note has turned positive and has reached levels last seen during the "taper tantrum" of 2013, and during the start and end of the previous hiking cycle in mid-2004 and mid-2006, respectively. The correlation between high-yield CDX spreads and 2y UST rate has also increased recently.”
“The sign of the correlations imply stock and credit markets tend to underperform when the market expects a more hawkish Fed, and vice versa.”
“The current elevated stock-bond returns correlation at about +40% was previously seen only when investors expected an earlier Fed turning point. For example, the correlation reached today's level in 2004 only after the Fed started hiking in June 2004. Similarly, the market pulled the expected timing of Fed hikes earlier by about eight months during the taper tantrum of 2013. This is not the case this time.”
“If anything, the OIS market has pushed the perceived timing of Fed hikes further in time to late 2015 or early 2016 (depending on assumptions about the level of the effective fed funds rate after the first hike). This suggests the underlying sensitivity of risky assets to Fed policy is greater than it has been historically, and it may increase to unprecedented highs if the Fed signals hikes this year.”
Key Quotes
“Risky assets have become highly sensitive to Fed policy expectations recently. Although stock and bond returns are normally negatively correlated, the 3m correlation between daily returns on S&P and 2y UST note has turned positive and has reached levels last seen during the "taper tantrum" of 2013, and during the start and end of the previous hiking cycle in mid-2004 and mid-2006, respectively. The correlation between high-yield CDX spreads and 2y UST rate has also increased recently.”
“The sign of the correlations imply stock and credit markets tend to underperform when the market expects a more hawkish Fed, and vice versa.”
“The current elevated stock-bond returns correlation at about +40% was previously seen only when investors expected an earlier Fed turning point. For example, the correlation reached today's level in 2004 only after the Fed started hiking in June 2004. Similarly, the market pulled the expected timing of Fed hikes earlier by about eight months during the taper tantrum of 2013. This is not the case this time.”
“If anything, the OIS market has pushed the perceived timing of Fed hikes further in time to late 2015 or early 2016 (depending on assumptions about the level of the effective fed funds rate after the first hike). This suggests the underlying sensitivity of risky assets to Fed policy is greater than it has been historically, and it may increase to unprecedented highs if the Fed signals hikes this year.”