Investment markets respond to Bernanke decision

Investment markets respond to Bernanke decision

The effect of yesterday’s decision by Federal Reserve chairman Ben Bernanke to keep up the US central bank’s level of bond buying is being felt within investment markets.

The Fed decided to continue buying long term Treasury securities at a pace of $45bn per month, and additional agency mortgage-backed securities at $40bn per month.

Bernanke said the central bank would continue reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities, and of rolling over maturing Treasury securities at auction.

The Fed chairman’s decision is aims to “maintain downward pressure on longer-term interest rates” – with consequences for insurers and reinsurers core fixed income asset portfolios.

“Markets have already moved to reassess the future trajectory of US monetary policy and are now pricing in a rise in interest rates at the end of 2014,” said Andrew Cole, investment director of Baring Asset Management’s global multi asset group.

“Elsewhere, riskier asset classes have also responded very favourably to the announcement, with global equities rallying strongly,” he said.

Bernanke’s statement cited an “improvement in economic activity and labor market conditions ... consistent with growing underlying strength in the broader economy.

“However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.”

While keeping his options open, any future tapering of Fed stimulus will be “balanced” with long-term goals in mind, noted Bernanke.

“Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases,” said the statement. 

According to Willem Verhagen, senior economist at ING Investment Management, the most important reason for not tapering the stimulus is that there has been "an unwarranted rise" in US Treasury yields, driven by a steepening of the expected path of future policy rates since the Fed met in July.

"This development threatens the Fed’s strategic game plan which is to allow for a prolonged period of robust above potential growth without tightening policy. This plan is crucial in igniting the interest rate sensitive components of demand at a time when the policy rate cannot be lowered further," said Verhagen.

"Over the past few months the Fed has been at pains to explain that forward guidance and QE are completely separate instruments where the former is deemed to be much more effective than the latter," said Verhagen. "Also, Bernanke has clearly stated that tapering merely means reducing the pace of easing which is something entirely different than outright tightening," he added.

From an investment perspective, the Barings analysis favours continued investment in equities within asset portfolios.

“Although we have valuation concerns, overall we expect equities to be the best performing asset class, with cash yielding close to zero and government bonds looking poor value and likely to suffer from the withdrawal of central bank support over the medium-term,” said Cole.

“Emerging equity markets have rallied particularly strongly overnight, but the structural issues facing a number of major developing economies currently leads us to favour developed equity markets such as the UK and Japan. We believe the UK is well placed to take advantage of the global recovery due to its impressive linkages overseas, while we expect further economic and structural reforms to boost the corporate side in Japan,” he said.

He suggested that Europe’s outlook is also improving, with higher GDP figures for the region being posted in the second quarter of 2013, although the outcome of Germany’s election remains a major uncertainty.

“While we are more cautious on the outlook for government bonds, we do see tactical opportunities here, particularly in the UK,” said Cole. “Gilts have suffered in recent months as market participants have failed to be convinced by the Bank of England’s rhetoric on when interest rate rises are likely to come.”

“We feel that the market has moved too far and that the recent underperformance of gilts should come to an end given that the Bank of England is unlikely to increase rates before the Federal Reserve in our assessment,” he added. 

For further analysis on the investment outlook, On September 26 the Lloyd’s Library will play host to the Reactions Insurance Investment Forum for CIO & CEOs.

Jim Reid, Deutsche Bank’s macro strategist for global markets, will give a keynote speech to kick off the 4-7pm event at Lloyd’s, which is free to register.

That will be followed by a panel debate and Q&A on re/insurance companies’ investment strategies, chaired by Reactions deputy editor David Benyon.

The panel line up is as follows:
Randy Brown, co-chief investment officer, Deutsche Asset & Wealth Management;
Francois deVarenne, chief executive of Scor Global Investments;
Patrick Liedtke, head of financial institutions group for EMEA, BlackRock;
Michael Kelly, global head of asset allocation, PineBridge Investments, New York;
and Steven Oh, head of global credit & fixed Income, co-head of leveraged finance, PineBridge Investments, Los Angeles.

Register here: http://www.reactionsnet.com/Stub.aspx?StubID=22783

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