Persistence of US inflation triggers portfolio rotation

by Carolina Mandl, Davide Barbuscia and Lewis Krauskopf

April 11 (Reuters) – The rebound in US inflation is pushing investors to prepare for a risk previously considered marginal: that the Federal Reserve does not lower its rates this year.

The number of rate cuts expected by markets in 2024 is decreasing rapidly with the latest data: at the start of 2024, markets were betting on 150 basis points (bps) of easing, compared to only 40 bps since the CPI inflation report, published Wednesday.

“The probability that there will be no rate cuts in 2024, or fewer cuts than the market expects, is becoming increasingly strong,” explains Tara Hariharan, director at the global hedge fund macro NWI.

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Faced with uncertainty, managers must reposition themselves after having exposed themselves to assets that benefit from rate cuts.

Some equity investors buy more options or gain exposure to inflation-protected sectors, such as energy. The S&P 500 is close to its records but lost almost 1% on Wednesday, and some traders fear that the index will continue its fall.

The bond segment has already started to correct, with the yield on the 10-year sovereign reaching its highest level since November on Wednesday, exceeding 4.5%.

Tim Murray, a strategist at T. Rowe Price, says he has divested from bonds because he fears inflation will erode sovereign yields.

“Sovereign securities protect against the risks of recession, but not inflation,” he emphasizes.

The manager also increased his exposure to energy-related stocks, which have soared this year thanks to the rise in the price of oil and their role as a hedge against inflation. The S&P 500 energy sector gained 17% in 2024, compared to 8.2% for the S&P 500.

Rick Rieder, head of bond investments at BlackRock, the world’s largest manager, says he has reduced the rate exposure of some of his portfolios by selling certain short and long maturity bond securities, which are more sensitive to changes in interest rates.

PIMCO, the bond giant, has conversely chosen to increase the duration of its funds, believing that valuations on the bond markets are now more consistent.

“To be honest, we are considering the moment from which we could overexpose ourselves” to these securities, notes Mike Cudzil, manager at Pimco.

Tara Hariharan believes that long-term yields on Treasuries are “too low, given the large supply of securities.”

Nervousness is also growing on the equity markets, with Bank of America noting in a note that market participants had sold $3.4 billion (€3.2 billion) worth of shares last week, with individual securities recording their strongest releases since July 2023.

Scott Wren, strategist at the Wells Fargo Investment Institute, specifies that the bank has “stored” its liquidity in short-term bonds and is waiting for a correction in stocks to return to the asset class.

“The next movement on Fed rates will be downward, but we will have to wait,” he adds.

Investors also seek protection on derivatives. The VIX volatility index, which measures demand for option hedging, is near a two-month high.

Citi strategists note, however, that the markets would need to reduce their expectations of rate cuts by 50 to 75 bp and that the yield on the American 10-year bond would increase by 5 to 35 bp over the coming weeks for a shock to materialize. on stocks.

Bryant VanCronkhite, portfolio manager at Allspring, believes that a continued rise in commodity prices represents a risk for stocks because it could push inflation higher again. The manager believes that it is difficult to predict the next direction of the equity markets.

“Quite honestly, I don’t know if they will gain 10% or lose 10%,” he concludes.

(Reporting by Carolina Mandl, Davide Barbuscia and Lewis Krauskopf, with Saqib Iqbal Ahmed, French version COrentin Chappron, edited by)