A major European asset management firm has indicated that the market may have misjudged the Federal Reserve! It is now advisable to go long on the US dollar and US Treasury bonds, while shorting these assets...
One of Europe's largest asset management companies, Pictet Asset Management SA, believes that the market's expectations for the Federal Reserve to cut interest rates this year are misplaced.
Pictet Asset Management is shorting interest rate futures, betting that these futures will decline in the coming months due to persistent inflation that prevents the Federal Reserve from reducing borrowing costs. The company's Global Head of Bonds, Andres Sanchez Balcazar, considers the market's expectations for policymakers to change course in September and begin cutting rates as "extreme." Balcazar stated:
"Unless something terrible happens, the Federal Reserve may find it very, very difficult to cut rates quickly. But that is not the current situation (referring to something terrible happening), which is why we believe it makes sense to short some contracts in the money market that seem overly optimistic about rate cuts."
Pictet Asset Management, which manages approximately $680 billion in assets, is primarily preparing for this by shorting SOFR (Secured Overnight Financing Rate) futures, which reflect investors' expectations for overnight borrowing costs in September and December. These futures contracts have rebounded in recent weeks as the money market bets on the Federal Reserve cutting rates by 50 basis points in 2023.
An increasing number of investors, including Pictet Asset Management and Amundi Asset Management, are betting that the Federal Reserve will begin cutting rates next year, thus anticipating a gradual steepening of the US yield curve.
These funds have purchased 5-year and 10-year US Treasury bonds while selling 15- to 30-year US Treasury bonds. Balcazar said:
"There is some uncertainty about whether the rate cut will occur at the end of the year or next year. But for us, the overall and long-term economic outlook is clear.
That is, the Federal Reserve will cut rates, the economy will slow down, and the likelihood of recession is increasing, so now is an appropriate time to hold US Treasury bonds, especially in the middle part of the yield curve."
In contrast, J.P. Morgan Asset Management believes that as the US economic growth slows, the market's bet that interest rates may start to decline in the third quarter is correct.The Federal Reserve raised interest rates by 25 basis points earlier this month, although officials seem to be divided on whether to pause further tightening of policy.
Balcarzal believes that ongoing inflationary pressures may keep US interest rates at the highest level in more than 20 years, at 5.25%, before 2024.
This year, the stress in the US banking system and mixed economic data have caused fluctuations in the interest rate market, leading to frequent dramatic changes in market expectations of whether the Federal Reserve will cut interest rates.
Balcarzal said that this has made it difficult to directly hold duration positions, so it is necessary to guard against market volatility.
He said that the US dollar is a "good diversification tool" for US Treasury risk, and given that the European Central Bank and the Bank of England will lag behind the Federal Reserve in curbing high inflation, Pictet Asset Management has been increasing its positions in US dollars against the euro and the pound.
Balcarzal also holds some short positions in UK government bonds and German government bonds, as he expects the Bank of England and the European Central Bank to continue raising interest rates.
- 9 September'24
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