Markets reacted sharply earlier this week after Federal Reserve Chairman Ben Bernanke’s latest Congressional testimony revealed the central bank discussed starting to taper its bond purchase program at the latest FOMC meeting.
But Heather Loomis, executive director of fixed income at JP Morgan Private Bank, feels Bernanke’s statement was very balanced, and the volatile reaction from the bond and the stock markets was more of a function of the markets grasping for some news and trying to read into both the prepared remarks and the Q&A. What Bernanke really said was more of the same – that we are going to be watching the data, that we have seen improvement, but we have yet still more improvement to see, she observed.
Asked if comments by the different Fed presidents added to the noise, Heather answered in the affirmative. Comments by the various Federal Reserve Bank presidents have not lent additional clarity to Bernanke’s statements, they probably added additional confusion. But if one could summarize the direction of them, it’s that: “we are watching this data closely”.
When the central bank takes its foot off the stimulus, it could cause volatile reactions in the bond market and for that reason the Fed is ready to step back in, she explained. But the Fed knows that at some point, the data series will become strong enough that they are able to (withdraw), she added.
Asked how she is preparing for the day when the Fed announces its decision to wind down the stimulus, Heather said she looks for embedded values in the trade when considering the core bond market.
However, the values are much smaller now than they have been in the years past. The maximum possible return of riding rates down to zero is something close to five percent for a five-year duration security, which simply is not enough for investors. As such she has been taking positions in core bonds down and moving into corporate credit, inflation protected securities and non-dollar securities, she added.
Asked if she is witnessing the ‘great rotation’ in the mutual fund industry where investors take out money from the bond funds and invest in equity funds, Heather said investors have not yet taken positions to exit the bond markets.
Nevertheless, there has been a great rotation of cash to bond and equity markets. Latest statistic indicates mutual funds are holding 6.7 percent of assets in cash, which mean the funds are worried about potential volatility and potential reversal of some of these flows, and hence preparing themselves for that, she noted.
Asked where she sees the most upside in the current super low-yield environment, Heather said it is better to look outside the fixed-income arena for higher total returns. Asked if he agreed with Bill Gross that the great bond bull market ended back in late April, she said it’s better to start preparing for an eventual rise in interest rates.
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