How Much Risk Does The Fed Pose To Your Portfolio?‍

At the beginning of February, the markets began to speculate about the possibility of a benign "no landing" outcome for the US economy. Since then, however, a series of inflationary signals have emerged in the labor data, inflation, and consumer consumption, forcing markets to rethink how far the Fed is willing to go in dealing with inflation. There is no question that China is poised for a resurgence in growth, and Europe is approaching an inflection point, so we suggest that investors look beyond the US to gain exposure to equity markets. The global consumer staples sector, such as energy, is tilted away from growth and towards value sectors, such as consumer staples and energy.

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Market risk is re-emerging as a primary factor driven by the Fed's rate path.

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• From mid-2022 until early February of this year, the futures markets consistently priced a lower terminal rate than the Fed's own base case—putting the peak at 4.8% at the beginning of February 2022.
• Following a range of inflationary data points, the rate has since risen to as high as 5.44%, which has caused many assets to be under pressure.
• DXY and UST 2-year yields rose 2.7% and 59bps, respectively.

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It isn't the only risk investors should be aware of.

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• It is possible that commodity volatility could be revived by risks such as an escalation in the Ukrainian war this spring, which has already disrupted global supply chains and rearranged global supply chains.
• The fallout from the air balloon incident, tech export controls, or Taiwan policies, could worsen US-China relations.
• A partisan showdown over the debt ceiling and the federal budget is also on the horizon in the US, where domestic pressure is also on the rise.

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Investors should re-evaluate their portfolio exposure now that the jury is still out on the US economy.

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• The momentum in China and Europe suggests that EM equities and markets like Germany might perform better than the US.
• Consumer staples provide some defensive exposure amid high inflation, including value stocks.
• There has been a delay in the inflection point in central bank policy, but it has not been derailed. The bonds that we like are high-grade, investment-grade, and emerging market bonds.

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Did you know?

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For at least six out of the previous nine months, the futures markets have priced a lower peak Fed terminal rate than the central case scenario that was used by the Fed at its meeting in February.

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The price of oil has declined by 30% from its peak, creating a supportive base effect that is causing headline inflation to fall much below the "core" readings that exclude food and energy as a result. US inflation expectations have risen back above the 3% mark despite several US rate hikes in the past few months and macroeconomic headwinds.

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Investment View

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Selective risk management is suggested, with less exposure to US equities and growth, and more exposure to defensive sectors like consumer staples. Through selective hedge funds, investors may protect their portfolios from choppy equity and bond markets, while some geopolitical risks may be hedged by energy exposure.

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