Topic Tags: Fixed Income - Global

The Sixth Fed Hike and Rising LIBOR

The Federal Reserve announced its sixth rate hike on Wednesday, with the target fed funds rate now 1.5% – 1.75%. The decision to increase rates was based on low unemployment and low inflation. Our chart this week takes a closer look at LIBOR (more formally known as the London interbank offering rate) and its relationship with the fed funds rate. As a matter of background, LIBOR is primarily used as the base rate upon which the floating rates for bank loans and private credit are set. For example, a bank loan with an L+400 rate means that it yields 400 basis points over LIBOR. As LIBOR rises, the bank loan’s yield rises.

As the chart shows, LIBOR demonstrates a strong correlation with the fed funds rate, which is the short-term interest rate controlled by the Federal Reserve. The blue line shows the rate hikes over the last three years. The purple line shows the corresponding rise in the three-month LIBOR, which is the most commonly used maturity of LIBOR for bank loans and private credit. On average, the three-month LIBOR is approximately 50 basis points higher than the fed funds rate; thus, LIBOR is currently around 2.0%.

The gray section on the right shows the fed funds rate (blue line) as projected by the fed funds rate futures curve. By applying the 50bp difference to the LIBOR curve, we can project LIBOR to approximately 2.5% for December 2018 and 3.0% for both December 2019 and December 2020. This means that we could expect a bank loan with an L+400 rate to yield about 6.5% in December 2018 and about 7.0% as of December 2019 and December 2020.

However, we must note that LIBOR is expected to be phased out by the end of 2021. In addition, the London Stock Exchange has been working on a new short-term benchmark interest rate that would replace LIBOR, and plans to launch this replacement rate in April. Marquette will continue to monitor and provide guidance on these LIBOR developments, as they will undoubtedly have an impact on how interest rates and the credit market are measured.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

2018 Market Preview

Each year, investors face numerous questions that can impact their portfolios, and 2018 is no different. How will tax reform further impact the capital markets? How much – and often – will the Fed raise rates in the coming year? Can international equities continue to outperform their U.S. counterparts?  Should we be concerned about the levels of dry powder in the private equity market? These topics among many others are covered in the following articles as we offer our annual market preview newsletters. In the links below, readers will find a preview newsletter for each asset class that we cover, as well as a general U.S. economic preview. Each article contains insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered. We hope that this set of articles can assist you and your committees as you plan for 2018. Should you have any questions about any of the content, please feel free to contact myself or any of the authors or consultants here at Marquette. We also have a webinar recording available by request if you would like to hear a high-level presentation of the topics presented in these articles. Happy New Year!

U.S. Economy by Jeffrey Hoffmeyer, CFA, Lead Analyst, Asset Allocation

Fixed Income by Ben Mohr, CFA, Senior Research Analyst, Fixed Income

U.S. Equities by Samantha T. Grant, CFA, CAIA, Senior Research Analyst, U.S. Equities & Rob Britenbach, CIPM, Research Analyst, U.S. Equities

Non-U.S. Equities by David Hernandez, CFA, Senior Research Analyst, International Equities

Real Estate by Jeremy Zirin, CAIA, Senior Research Analyst, Real Assets

Infrastructure by Jeremy Zirin, CAIA, Senior Research Analyst, Real Assets

Hedge Funds by Joe McGuane, Senior Research Analyst, Alternatives

Private Equity by Derek Schmidt, CFA, CAIA, Senior Research Analyst, Private Equity

Will the Fed “Normalize” My Investment Returns?


Flash talk by Ben Mohr, CFA at Marquette’s 2017 Investment Symposium

In this session, we review common terms and concepts in fixed income including Fed rate hikes and the Fed’s balance sheet, and explore how each concept can assist investors in modeling bond returns. We also examine potential outcomes of the upcoming change in Fed leadership and FOMC and impacts on client portfolios.

Central Bank Balancing Act

The Federal Reserve continues to signal its intention to reduce its $4.5 trillion balance sheet, with the markets anticipating the first move to occur in September. Much of the liquidity, and consequently, asset returns, in the global markets today could be attributed to the substantial bond and other securities purchases made by the major central banks, thereby ballooning their balance sheets.

Our chart this week shows the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ) balance sheets over time, totaling $14 trillion today. While the Fed has effectively stopped growing its balance sheet since 2014, the ECB and BOJ continue to expand their balance sheets. With the U.S. enjoying the strongest economy relative to Europe and Asia, the Fed will be the first to taper its balance sheet. This move would effectively slow down stimulus in the U.S., with the ECB and BOJ’s balance sheet tapering to follow at some point in the future when their economies have resuscitated. The Fed has been broadly communicating the mechanics of its tapering, and we expect the markets to respond relatively moderately to the first reduction event.

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Growing Bond Market in China

Our chart this week shows the five largest bond markets in the world. We will focus on China and highlight a few reasons why the Chinese bond market is projected to overtake Japan in the next few years.

For starters, up until last year capital controls put in place by the Chinese government were designed to limit foreign investment. As a result of some newly implemented reforms since then, international investors have slowly been allowed direct access to the Chinese domestic bond market. For example, on July 3, 2017 Beijing and Hong Kong opened a trading link which will allow investors based in Hong Kong to trade directly in the Chinese bond market.

Additionally, in March Citigroup announced the inclusion of Chinese onshore bonds in several of its market indices and more recently Bloomberg announced similar plans. Inclusion in multiple market indices will aid in growth while increasing foreign investment.

Finally, new rules recently implemented in China require the country’s 22 provinces to borrow in the local government bond market instead of seeking out bank financing which had previously been the preferred route. This change should also contribute positively to the continued expansion of China’s bond market and will offer greater access to more investors.

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2017 Market Preview

January 2017

Similar to past market preview newsletters, we enter the year with a new set of questions. What shape will Trump’s policies take and how will they impact the market? Will the formal start of the Brexit have an impact on portfolios? To what degree and pace will the Fed increase interest rates? These topics among many others are covered in the following articles as we offer our annual market preview newsletter. Each year presents new challenges to our clients, and other headlines will emerge as the year goes on; it is critical to understand how asset classes will react to each new development and what such reactions will mean to investors. The following articles contain insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered. Recognizing that many of our clients may not have time to cover the following 30 pages of material, we offer the primary conclusions for each asset class heading into 2017.

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What Does the Fed’s Rate Hike Mean for 2017?

December 2016

On December 14, 2016, the FOMC announced its unanimous decision to raise interest rates by 25 basis points, bringing the target fed funds rate to between 0.50% and 0.75%. This was the first increase since last December’s, with the hike prior to that occurring in 2006 before the Great Recession.

This move was widely anticipated and well-communicated to the markets. As such, fed funds futures carried a 100% implied probability of a hike going into it, and most – if not all – of the hike was already priced into global markets. Markets over the past one and a half days since the hike have remained relatively calm. The 10-year Treasury yield rose by only 12bp to end at 2.6%, while the one-year Treasury yield rose by just 3bp to end at 0.9% and the 30-year Treasury yield rose by 2bp to end at 3.1%. The Core Aggregate bond index and the Intermediate Government/Credit index were down only 0.5%, while the 1-3 Yr Government/Credit index fell 0.2%; the Long Government/Credit index also decreased 0.2%. The Credit Suisse Leveraged Loan index was up 0.1%, the Credit Suisse High Yield index was down 0.3%, and the JPMorgan emerging markets debt EMBI Global Diversified index decreased by less than 0.1%. The dollar rose while gold declined, as expected. The S&P 500 declined less than 0.1%.

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The Impact of Trump’s Victory on Capital Markets

November 2016

To the surprise of pollsters, analysts, and much of the American public, Republican presidential candidate Donald Trump trampled predictions by winning the presidential election in stunning fashion.

The long-term impact of Trump’s presidency on financial markets is impossible to predict at this point, given the amount of uncertainty around his expected policies. However, the short-term dynamics surrounding his election win are starting to emerge, and we share with you what we are seeing and hearing in the market in this newsletter.

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Global Bonds and Negative Yields

This week’s chart examines the change in yield for global sovereign debt. While we have been in a low interest rate environment since 2008, over the last three years, we have seen negative yielding bonds move from 0% of the developed bond universe to 38%. A staggering number indeed, this has been the by-product of anemic global growth and aggressive monetary policies in Europe and Japan.

This week’s chart examines the change in yield for global sovereign debt. While we have been in a low interest rate environment since 2008, over the last three years, we have seen negative yielding bonds move from 0% of the developed bond universe to 38%. A staggering number indeed, this has been the by-product of anemic global growth and aggressive monetary policies in Europe and Japan.

One of the consequences of a negative rate environment is increased demand for higher yielding assets. Through the second quarter, U.S. high yield and emerging market debt have returned 9.1% and 10.3%, respectively. In addition to attractive yields, these asset classes have benefitted from stability in commodity prices and minimal exposure to the Brexit event. Should these conditions persist going forward, expect investor preference for credit and higher yielding bonds to continue, given this historically low interest rate environment.

2016 Market Preview

January 2016

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2016 is off to a volatile start with equity markets down significantly, oil dropping below $30, the Fed poised to further increase interest rates, and fears of a China slowdown rippling through the markets. However, other headlines will emerge as the year goes on, and it is critical to understand how asset classes will react to each new development and what such reactions will mean to investors. The following articles contain insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered.

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