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The Federal Reserve (Fed)’s no-taper announcement was certainly a surprise. I had expected a ‘taper lite’ rather than a hold.

Still, the announcement is consistent with my expectation that the US recovery will remain slow and that interest rates are likely to finish the year around where they are now.  By failing to taper, the Fed signalled to the market that there are still lingering questions regarding the strength of the US recovery. Of particular concern is the resilience of the housing recovery in the face of rising interest rates.

What does this mean for investors? As I write in my latest weekly commentary, the Fed’s decision confirms some of my asset allocation views and tempers others. In particular, there are four asset allocation implications of the Fed news:

1.)    Rate-sensitive assets may get a temporary reprieve after the Fed news, but I remain underweight two such asset classes: global utility stocks and gold. While I recognize that softness in these assets may be delayed because real interest rates will not rise as quickly as investors had feared, I still expect real rates to rise over the longer term.

2.)    I remain overweight equities versus bonds. A slower taper suggests easier monetary policy for longer, a development which is consistent with our overweight view of global equities.

3.)    Within equities, more aggressive investors should consider overweighting emerging markets. A more accommodative monetary policy is supportive of emerging markets.

4.)    Within fixed income, I continue to favor credit sectors over Treasuries. An environment in which rates are contained but economic growth continues is likely to be supportive of high yield bonds.

Beyond specific asset allocation implications, the Fed’s decision was also a tacit acknowledgement that Washington can still cause market mischief.

As I wrote earlier this month, I expect that market attention is soon going to switch to the Congressional budget battle, meaning there’s likely more market volatility ahead. In his comments, the Fed chief himself cited the potential for volatility around the upcoming budget battle.

 

Source: Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.

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In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.