Janet Yellen, chair of the U.S. Federal Reserve, speaks during her semiannual report on the economy to the Senate Banking Committee in Washington, D.C., U.S., on Thursday, July 16, 2015. Yellen said the Federal Reserve is "highly focused" on the risks of raising interest rates too early. Photographer: Drew Angerer/Bloomberg *** Local Caption *** Janet Yellen
Janet Yellen, Federal Reserve chair © Bloomberg

Fear can often drive markets — a fact that has not escaped the attention of the US Federal Reserve after the central bank held fire over raising rates.

Investors say the dovish hold, with a Fed statement that acknowledged the fragility of emerging markets and pointed to concerns over low inflation, was influenced by the recent bout of market volatility and falls in stock prices.

It also reinforced views that developed world equities are the place to stay invested, with worries of a hard landing in China and the dangers of a further unwind and sell-off in emerging markets the biggest risk for portfolio managers.

John Roe, head of multi-asset funds at Legal & General Investment Management, said: “The Fed fears going too soon with a rate rise, particularly after a very tough August, with elevated volatility and big falls in equities.

“In the past, we used to talk about the ‘Greenspan put’ [where the former Fed chairman eased monetary policy to boost markets]. Now there seems to be a ‘market put’. The big fall in the equity markets has been partly responsible for deterring the Fed from raising rates.”

LGIM immediately increased its overweight positions in US equities. It also has overweight positions in UK, Europe and Japanese equities, but is underweight emerging market stocks.

Other fund managers agree with LGIM.

JPMorgan Asset Management, Henderson Global Investors and UBS Wealth Management are all holding overweight positions in developed world equities while trimming positions in developing world stocks.

chart: Dollar

Simon Smiles, chief investment officer for ultra high net worth at UBS Wealth Management, said: “There is improving economic growth in the US, the eurozone and Japan. I think that is likely to last, which is supportive for equities in these markets.

“We have seen some surveys [Bank of America Merrill Lynch and Citigroup] that have warned of recession, but I don’t think that is likely in the foreseeable future. We have supportive central bank policy in Europe and Japan and the US economy is robust. This all supports stocks.”

Talib Sheikh, managing director of multi-asset solutions at JPMorgan Asset Management, said: “It has been about four years since emerging markets have underperformed developed world stocks. That is likely to continue as the engines of growth are in the US and UK, while the eurozone economies are picking up.”

However, some fund managers remain neutral on US equities because of high valuations and relatively muted earnings growth this year. UBS Wealth moved from being overweight to a neutral stance on US equities this year, while Henderson is also neutral on US stocks.

chart: MSCI stocks

Matthew Beesley, head of global equities at Henderson, said: “Without earnings growth, the markets are going to go nowhere from here. Earnings have been a bit disappointing in the US, so that has to be a concern.”

However, he points out that the US is in relatively good shape and is one of the world’s strongest economies. It is also in the unusual position of being one of the only major economies, with the exception of the UK, where policymakers are considering rate rises.

For fixed income investors, the dovish Fed statement, which saw growth and inflation both revised down, was positive — with government bonds and credit markets, along with Treasuries, rallying strongly in price, resulting in lower yields. That mood was emulated across bond markets in Europe and the UK on Friday.

Andrew Wilson, chief executive of Goldman Sachs Asset Management in Europe, said: “The Fed statement was not quite as hawkish for bond markets as some feared. This means government bond yields will stay in these low ranges for a while yet, although there is an upward bias. The statement was also constructive for credit and corporate bonds.”

Although the market has pushed back expectations of a rate rise to next year, with December considered just under 50 per cent likely, Mr Wilson stresses that the Fed is still looking to increase rates by a full percentage point in 2016.

Mike Amey, senior bond portfolio manager at Pimco, said: “The Fed statement is supportive of risk assets, which favours credit and corporate bonds over government bonds. We are overweight credit and broadly neutral to underweight government bonds.”

In the currency markets, the strong dollar and the potential for further depreciation of the Chinese renminbi are the big factors influencing investment and trading positions.

The dollar eased on the dovish announcement, but it remains at a 12-year high as measured by the Fed’s own trade weighted calculations.

“Are we in a dollar supercycle?” asked Mr Beesley. “A strong dollar is bad for emerging markets and commodities. The strength of the dollar is partly why we are very bearish on emerging markets and commodities.”

At the same time, further depreciation in the Chinese currency would hit emerging markets, particularly other Asian economies such as South Korea and Taiwan.

These currency factors mean the Fed has to move cautiously.

“The Fed is right to be sensitive about raising rates too soon,” said Mr Smiles. “The single greatest risk to the world economy and markets is the unwinding of extraordinary monetary policy. The Fed cannot afford to make the hawkish mistake and send markets into a downward spin.”

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