The Federal Reserve’s decision to start shrinking its balance sheet later this year could lead to volatility across equity markets, according to a range of investment professionals.
The Federal Reserve signalled in September that it is to begin reducing the quantity of assets it owns on its balance sheet through the sale of government and corporate bonds, at a rate of $10bn (£7.47bn) a month.
That action will likely lead to an increase in bond yields, and to interest rates.
James Sullivan, multi-asset investment manager at Coram, said: “The expansion of the Fed balance sheet quite clearly coincided with the liquidity fuelled appreciation of many markets (since the financial crisis), notably the S&P.”
He said that if economic data doesn’t improved markedly from here, then “the odds would suggest” that the Federal Reserve shrinking its balance sheet could have the effect of causing the US market to under perform, in the same way that the bond buying programme caused the market to perform well.
Mr Sullivan said: “This has led us to invest in markets that remain supported by loose monetary policy, or where the valuations are more appealing. Markets such as Japan and Germany.”
Peter Elston, chief investment officer at Seneca Investment Management, has no exposure to US equities, as he feels equities traditionally under perform in the later stages of the economic cycle, and the Federal Reserve’s actions indicate the US is closer to the end of the cycle than any other developed economy.
Adrian Lowcock, investment director at Architas, said: “Investors need to act now as central banks tighten policy.”
He said: “For the past 10 years central banks have been a strong tailwind supporting the bond market. The announcement by the US Federal Reserve means that has changed and the 30 year bull bond market is coming to an end.
"Investors should expect bond yields to rise, which means prices fall.”
Mr Lowcock said investors should be prepared to move their bond allocation to funds such as the £1.15bn Artemis Strategic Bond fund, which are more flexible than other fixed income mandates and so more capable of coping with the fall in bond prices.
Bryn Jones, who runs the £882m Rathbones Ethical Bond Fund, which is the absolute top performer in the IA Sterling Corporate Bond sector this year to date and over the past five years, said the bond market has largely “priced in” the impact of the Federal Reserve reducing its balance sheet.
Mr Jones said central banks have extensively “telegraphed” their plans to sell bonds, so the market is presently pricing this.
Simon Edelsten, who runs the £74m Artemis Global Select fund, said the market has been aware that tapering would happen since 2013, with the obvious parts of the equity markets, including emerging markets, having taken actions to mitigate the risks from tapering.
He said markets have been “calm” since the balance sheet reduction plan was announced.