Impact Blog
Will volatility derail the Fed's rate-hike plans?

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Calvert disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Calvert are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Calvert fund. References to individual companies for Engagement or Research purposes are provided for illustrative purposes only and may not be representative of the results of all of Calvert’s engagement efforts. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

  • All Posts
  • More
    Topics
      Authors
      The article below is presented as a single post. Click here to view all posts.

      By Vishal Khanduja, CFA, Calvert Fixed Income Portfolio Manager and Brian S. Ellis, CFA, Calvert Fixed Income Portfolio Manager

      Boston - The recent volatility has been at least partly driven by markets reacting to higher interest rates and a Federal Reserve that appears committed to further tightening. We expect more turbulence as investors realize the Fed and even other central banks are determined to pull back accommodative monetary policies that have supported markets since the financial crisis.

      Corporate tax reform is boosting the U.S. economy, which is in its second-longest expansion since the Civil War. Tax reform has delivered both short- and long-term impacts. The most meaningful impacts over the shorter term should continue to drive above-trend growth for the next few quarters. This should contribute to continued outperformance of the U.S. versus other major global economies. At the same time, we expect inflation to continue trending higher but to remain under control.

      We don't see any reason for the Fed to veer off of its current course of gradual interest-rate hikes. If there is a surprise from the Fed, it will likely be more aggressive tightening to counter late-cycle inflationary pressures or the effects of fiscal stimulus. ECB policy could also take a more hawkish turn. In late September, President Draghi said that the ECB expects "a relatively vigorous pickup in underlying inflation," a statement that sent global bond yields higher.

      The U.S. has implemented various tariffs, and there are signs that these tariffs are raising costs in certain sectors of the economy, a situation we are closely watching. That said, we remain optimistic that the U.S.'s tough stance on trade is part of a strategy to negotiate more favorable trade terms for the U.S. and not the start of a global trade war. The White House recently announced a trade deal with Mexico and Canada and is in negotiations with the EU and Japan — developments that suggest China is the focus of U.S. trade policy. With respect to China, it remains to be seen whether the administration will be able to reach an agreement. This poses downside risk to financial markets.

      In addition to global trade, we are also monitoring the U.S. midterm elections, as well as the looming Brexit deadline, the fiscal policy of Italy's new populist government and the imbalances facing several emerging economies. Domestic risk markets largely ignored these and other geopolitical hot spots during the third quarter. Going forward, we believe one or more of these issues will eventually have an impact. Meanwhile, U.S. interest rates continue to rise and will likely come under additional pressure given the government's need to finance significantly higher budget deficits in the near term.

      Given the lower return/higher volatility environment that we anticipate, we believe a conservative positioning remains appropriate. We also favor slightly shorter-than-benchmark interest rate durations and exposure to TIPS as a hedge against inflation.

      In terms of sector allocations, we favor short-duration investment-grade credit, as flat yield and credit curves make the risk-return tradeoff very attractive. Within this area of the market, we like floating-rate securities. We are also favoring bank loans as an alternative to high-yield bonds in portfolios that invest in high-yield debt. We continue to favor asset-backed securities that are sensitive to housing and household balance sheets but are monitoring the effects of higher interest rates and gasoline prices on the consumer.

      Bottom line: Against this backdrop, we expect returns on financial assets to lag their long-term averages over the coming quarters. We also think volatility will pick up as major foreign central banks join the Fed in tightening global liquidity.