Investment, Market news | 4 June, 2019

The Federal Reserve facing the loss of economic dynamism

Joaquín González Portfolio Manager

Preliminary US activity indicators point to this loss of economic dynamism in the U.S. occurring in the second half of the year. The market is also currently relying on the Federal Reserve to cut back the official rates twice in the next twelve months, meaning that the official rate would decrease from 2.5% to 2%.

On 6 May last year, we published a feature where we concluded: “so, in our opinion, a conservative long-term investor who would be willing to assume moderate volatility could invest in long-term US treasury bonds”. The annual yield (IRR) then offered by 10-year US treasury bonds was around 3%.

The rationale for this recommendation was based on the fact that the economic activity in the US may become less dynamic due to the Fed’s hardening of monetary policies (by increasing official rates from December 2015 onwards). The IRR offered by long-term US Treasury bonds could, therefore, decrease considerably.

The yield offered on these assets is still closely related to the growth expectations for the US economy.

In light of the above, if the IRR offered by the 10-year US Treasury bond was to drop to around 2%, the exposure to this asset ought to be ideally reduced significantly (by two thirds). The remaining exposure could be maintained in the event that the US economy was to slump more quickly than currently expected and the IRR of the 10-year bond was to drop down to 1.5% (2016 minimums).

What could an investor do in a situation like this?

  1. Maintaining liquidity while awaiting new investment opportunities offered in the markets.
  2. Short-term US Treasury bonds (e.g. two-year bonds) with volatility (price fluctuations) are much less preferable to long-term U.S. Treasury bonds.
  3. Please speak with your advisor to check which assets would be a good alternative investment at this time, that is always the best option.

The probability of recession in the US increases significantly

Based on the Federal Reserve Bank of New York index, the probability that the United States will fall into recession in the next twelve months has increased significantly.

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