Navigating Fed Pivot – Switch to quality


Switch to quality plays in rising rates environment
Chief Investment Office18 Jan 2022
Photo credit: AFP Photo


US inflation sees no respite as supply chain pressure persists. US headline inflation hit 7% in December last year and this is the highest level attained since June 1982. More importantly, “core” inflation, which excludes volatile items such as food and energy, was equally strong at 5.5% and this, again, is the highest level seen since February 1991. Apart from elevated energy prices, the other key factor driving inflation higher is the persistence of supply chain disruption.

Indeed, the concoction of manufacturing disruption during the pandemic and surging consumer demand triggered the crisis and data compiled by the Federal Reserve Bank of New York suggest that supply chain pressure remains elevated globally. This does not auger well for the outlook on inflation.

Fed Pivot: The start of Fed policy normalisation. Fed Chair Powell has, for the longest time, maintained that US inflationary pressure is “transitory”. But he has since done a volte face and pivoted to a new narrative, asserting that the US economy is strong and hence tighter monetary policies are warranted.

The latest inflation data, coupled with the new Fed pivot (and a looming midterm election), suggest that policy tightening is on the cards. We expect the Fed Funds rate to hit 1.00% and 1.75% by end-2022 and end-2023, respectively.

Figure 1: US inflation stays elevated amid persistent supply chain issues

 

 Source: Bloomberg, DBS

Fed normalisation will have limited impact on S&P 500; Big Tech to outperform Emerging Tech in rising rates environment. As we have previously discussed in 3Q21 CIO Insights – Hope into Reality, equity markets rallied throughout the previous Fed hiking cycle and this time shall be no different given the resilience of corporate earnings. As bonds yields grind higher in the coming months, investors are advised to shift to income-generative quality plays.

During the recent selloff in “Emerging Tech” or “long duration” Technology stocks on concerns of rising yields, it is evident that the profitable Big Tech space stayed resilient and have vasty outperformed the less profitable “Emerging Tech” segment. We expect this divergence to persist.

Figure 2: Fed rate hike has limited impact on S&P 500; Big Tech to outperform

 

Source: Bloomberg, DBS

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