As my colleague Rick Rieder noted in a post earlier this week, the Federal Reserve (Fed)’s recently released minutes and Jackson Hole Symposium comments suggest that a period of rate normalization is approaching.
In other words, while rates should remain relatively low over the long term and the rate normalization process will be a slow one, the Fed is likely to begin raising rates in the first half of 2015, and the first rate hike could come as early as March, earlier than many market watchers expect.
Rick covered a bit about what this means for the markets and the economy, but you may still be wondering how to position your portfolio for normalizing rates. In my last weekly commentary, “Rethink ‘Safe Havens’ as Rates Ready to Rise,” I advocate caution toward these two asset classes.
Treasury bonds with two- to five-year maturities. While longer-term interest rates have remained stable, the prospect for an early Fed tightening is exerting downward pressure on the prices of shorter-maturity Treasury bonds — particularly those with two- to five-year maturities — and pushing yields higher. I continue to advocate caution toward these maturities, as I expect they will prove the most vulnerable if the Fed does in fact accelerate the timetable of the first rate hike.
Commodities like gold. In addition to short-maturity bonds, another asset class that is proving vulnerable to rising rates is commodities. The prospect for tighter monetary conditions is driving the dollar higher and putting downward pressure on many commodities.
Stronger economic data and the prospect for tighter monetary conditions recently pushed the dollar to its highest level since last September. Along with a stronger dollar, the potential for higher real (i.e., inflation-adjusted) rates and a declining geopolitical risk premium have pushed the gold price down 5% from its July high.
Other commodities have suffered as well: Most agricultural commodities are down between 5% and 10% year-to-date, and oil prices have slid on less angst over Iraq and the Middle East. Among these various commodities, I remain particularly cautious of precious metals given their sensitivity to higher real rates.
As for which asset classes I like, I continue to prefer stocks over the “traditional “safe-haven” assets I mention above. Why? Traditional “safe haven” assets such as short- to intermediate-duration U.S. Treasuries and gold may, in fact, be more vulnerable than stocks in the near term as a period of interest rate normalization approaches. Although not cheap, stocks have the tailwinds of still-low rates and improving economic conditions at their back.
The stock market continues to wrestle with a series of counterforces, and for now, low rates and an improving U.S. economy are trumping full valuations and lingering geopolitical risks, allowing stocks to move higher.
Sources: BlackRock, Bloomberg