There is a growing likelihood that the Fed will hike interest rates this year for the first time since 2006, says BlackRock’s Chief Investment Strategist Russ Koesterich.
According to Koesterich, evidence to support that view came from the December employment report released on Friday.
“Job growth continues to accelerate, as evidenced by the 252,000 in net new jobs last month. The previous two months’ totals were also revised higher by 50,000. True, wage growth unexpectedly fell and the labor participation rate is still stuck at a 37-year low. But these issues are structural, not cyclical, and, therefore, do not lend themselves to continued monetary accommodation”, Koesterich states.
Hence, with the economy on solid footing, the Fed should start to move sooner rather than later, probably by June
What implications will the expectations for hiking interest rates brings to investor?
First, volatility is expected to be elevated compared to the levels witnessed from 2012 to 2014. “This suggests strategies that thrive in “low vol” environments—notably momentum—may struggle this year. Instead, we suggest investors consider more value-oriented and high-quality names in a portfolio”, Koesterich says.
Second, investors should should be more tactical within fixed income. According to Koesterich, bonds with maturities in the two- to five-year range are likely to prove the most vulnerable to higher interest rates.
“It is worth highlighting that while 10-year Treasury yields are down over 1% from a year ago, two-year yields, which are more sensitive to the Fed, have actually risen since the start of 2014.”
BlackRock’s best advice is to consider a “barbell strategy,” emphasizing longer-maturity bonds balanced against those with very short maturities. According to Koesterich, this is particularly true for tax-exempt bonds, which still offer good value for long maturities.