Opportunities from rising interest rates

Interest rate movements have been one of the key developments since 4Q16 and US 10-year Treasury yield has risen as high as 2.6% to date. 

However, since the rate hike in March this year, expectations for higher Fed rate hikes have moderated. A slow patch of economic data including a weak print in 1Q17 US GDP as well as a “dovish hike” branded by the market contributed to this decline.    

Higher interest rates became the focus again in June. First of all, the Fed stuck to its guns and hiked rates. The minutes of the FOMC meeting also raised the possibility of announcing the balance sheet reduction program in the 2nd half of the year. A number of central banks have also spoken with a more hawkish tone recently. For instance, ECB’s Draghi, in a speech in this late June also gave an impression that tapering and balance sheet reduction for the ECB could come sooner.

All of these talks have caused immediate impacts on the bond markets when benchmark yields for major government bonds rose by more than 20bp the last week of June. The market is just starting to reprice a further increase in rates, and the central banks to rein in the liquidity as a “clear and present” risk.

In light of such expectations, we believe investors would need to refocus on the rising interest rate theme. Our forecasts for the US 2-year and 10-year Treasury yields are 1.90% and 3.00% respectively. The focus for investors could be:

1.   Hedging and managing interest rate risks in light of tighter liquidity and  higher interest rates, for exposures both in asset side and liabilities side.

2.   Which asset classes and investment solutions are best suited to a rising rate and tighter liquidity environment?