A significant portion of U.S.-based asset managers think further Federal Reserve rate hikes would lead to a recession or some disruption in global financial markets, according to research last month by London-based CoreData Research.
The greatest anticipated risk of continued Federal Reserve rate hikes is a possible recession. Overall, 59% of survey respondents took a neutral look at a recession scenario, that there would be “a moderate recession in 2023, followed by a gradual recovery as central bank policies bring down inflation over time,” while 14% opted for a bull case, defined as “a mild recession in the first half of 2023, followed by a strong recovery, falling inflation and rising equity markets [in the second half of 2023],” and 27% said they agree with a bear case, defined as a scenario in which “stagflation and a deep recession [occur] in 2023, accompanied by a 10-20% fall in the equity markets, as central banks struggle to defeat inflation which remains high.”
In predicting the market’s future performance, there was great disparity between views of respondents with smaller asset pools ($250 million to less than $1 billion in assets) and those with larger asset pools ($10 billion or more in assets). The bigger money managers were 67% neutral case, 29% bear case and only 4% bull case, whereas the smaller money managers were 45% neutral case, 25% bear case and 30% bull case.
The survey also found that 43% of respondents think that the Federal Reserve will be unable to raise interest rates much above 5% due to the economic damage and financial stress that would follow.
Confirming the suspicions of these asset managers: At a fed funds rate of 5%, the U.S. government would pay more than a trillion dollars annually in interest on its debt. At a 5.5% terminal rate, where Wall Street most recently has said the terminal rate ends up peaking in this rate-hiking cycle, the U.S. government would see the interest servicing portion of its debt overtake Social Security as the biggest annual federal expense, according to the Peter G. Peterson Foundation. Current CBO projections have interest payments totaling $66 trillion over the next 30 years, with the model using an assumption of a 3.1% interest rate by 2032, with that figure increasing to 4.2% by 2052.
Increasing from a consistent federal funds rate of .08% in the fourth quarter of 2021 to an average federal funds rate of 3.75% during Q4 2022 ballooned the U.S government’s quarterly interest payment on its debt to $213.3 billion in Q4 2022, increasing 42% from its interest payment of $150 billion during the same period a year prior.
Not all outcomes regarding higher rates would be negative, as the rate moves have the same asset managers are eyeing positions in fixed income, and 32% said they were planning to allocate more toward cash if rates move to 5% or higher. Consistent with this, more than half (55%) plan to increase allocations to fixed income if the Federal Reserve raises rates to 5% or more.
Within fixed income, 36% of respondents said they are increasing allocations to investment-grade corporate bonds, the most of any fixed-income subtype, and 33% are set to increase allocations to government bonds. A further 23% of respondents said they plan to cut their exposures to emerging-market debt as a consequence of higher yields domestically.
“On the one hand, institutional investors harbor deep concerns about higher interest rates triggering an economic tsunami whose waves will reverberate through the U.S. financial system,” said Andrew Inwood, founder and principal of CoreData, in a statement about the survey. “But on the other hand, higher interest rates now offer better income opportunities after a prolonged and frustrating search for yield in the post-financial crisis low-rate environment. The income has finally returned to fixed income.”
The most unanimously consistent data point in the survey was that 97% of U.S. asset managers surveyed said that they will not be raising an allocation in crypto or digital in the current environment. Furthermore, 61% of respondents do not invest in crypto assets in any capacity.
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Tags: Andrew Inwood, CoreData Research, Crypto, fed funds rate, Federal Reserve, Inflation, Interest Rates, rate hiking, Recession, risks