Western Asset Portfolio Manager Sees Opportunity Even As Fed Begins Raising Rates
PASADENA, Calif., Oct. 20, 2014 /PRNewswire/ -- Market watchers have come to believe the U.S. Federal Reserve Bank will soon start the process of raising interest rates. Amid nods in this direction from the Fed, U.S. corporate and emerging market bonds have underperformed over the past few weeks. That signals to some that non-Treasury spread sectors in the fixed-income markets will encounter difficulty in generating excess returns as rates rise.
In a white paper published recently, "Fed Hikes and the Impact on Spread Sectors," a Western Asset portfolio manager and research analyst challenges those views.
"We hesitate to draw conclusions about the prospects for Fed tightening based on a few weeks of choppy markets," writes John L. Bellows, PhD. A former senior official at the U.S. Department of the Treasury from 2009 to 2011 under Secretary Tim Geithner, Mr. Bellows and his team "continue to think financial conditions can remain accommodative amid a rise in rates. In such an environment, we would expect spread sectors to continue to outperform."
This conclusion is based on four factors: longer-term bond yields are likely to remain low; the broader set of Fed policies should remain accommodative; private credit creation has accelerated, which could lead to greater private lending; and history suggests a Fed hiking cycle and accommodative conditions can coexist.
The most important factor is the first, as an increase in overnight interest rates may not translate into higher long-term interest rates, which have a far greater impact on the economy. Low long-term rates should be good for corporate investment and residential construction. Meanwhile low discount rates will provide a tailwind to equity and real estate valuations, and demand could remain high for non-Treasury fixed-income spread sectors.
Mr. Bellows cites a chart that details the last four Fed hiking cycles. When the Fed raised rates to slow inflation that was already over the Fed's target, as in 1979 and 1988, long-term rates moved far more significantly. When the Fed did so in 1994 and 2004, its intent was to prevent excesses from building, and the impact on long-term rates was far less.
"Our view is that longer-term interest rates will remain relatively low even as the Fed increases overnight rates," Mr. Bellows writes. "This outlook reflects our expectation that inflation will remain relatively moderate (usually higher inflation is the primary reason why longer-term interest rates would rise)."
Mr. Bellows concludes that "we think the current backdrop supports spread sectors, and we believe that moderate overweights, combined with opportunistic duration strategies, present the best chance for success." He adds that, "While recent choppiness warrants thoughtfulness, we have not changed our view that spread sectors can outperform even as the Fed raises rates."
To read the Western Asset Policy Matters white paper, please click here.
For information on Legg Mason's fixed income offerings, please visit this web site: www.leggmason.com/fixedincome
About John L. Bellows, PhD
John Bellows is a portfolio manager/research analyst at Western Asset. He joined the Firm in 2012. From 2009 to 2011 he served in the U.S. Department of the Treasury in three capacities: Acting Assistant Secretary for Economic Policy; Deputy Assistant Secretary for Microeconomic Analysis; and Senior Advisor in the Office of Economic Policy. Mr. Bellows earned a PhD in Economics from the University of California, Berkeley, and a B.A. in Economics, magna cum laude, from Dartmouth College.
About Western Asset
Western Asset is one of the world's leading fixed-income managers with $471 billion in assets under management as of August 31, 2014. The firm is a wholly owned, independently operated subsidiary of Legg Mason, Inc. (NYSE: LM) From offices in Pasadena, Hong Kong, London, Melbourne, New York, Sao Paulo, Singapore, Tokyo and Dubai, the company provides investment services for a wide variety of global clients, across an equally wide variety of mandates.
About Legg Mason
Legg Mason is a global asset management firm with $708 billion in assets under management as of September 30, 2014. The Company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
All investments involve risk, including loss of principal. Past performance is no guarantee of future results.
Investments in fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. An increase in interest rates will reduce the value of fixed income securities.
©2014 Legg Mason Investor Services, LLC, member FINRA, SIPC. Legg Mason Investor Services, LLC and Western Asset Management Co. are subsidiaries of Legg Mason, Inc. TN14-445
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SOURCE Legg Mason, Inc.
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