Special Fed Coverage: How Investors Should Read a Rate Hike

Summary

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WSJ Your Money Briefing

Episode: Special Fed Coverage: How Investors Should Read a Rate Hike
Date: December 19, 2018
Host: JR Whalen
Guest: Greg Peters, Senior Portfolio Manager at PGIM Fixed Income

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Episode Overview

This special edition focuses on the Federal Reserve's decision to raise interest rates for the fourth time in 2018 and what it means for investors and savers. Host JR Whalen is joined by Greg Peters of PGIM Fixed Income to discuss how market expectations have shifted, how investors might navigate uncertainty, and what higher rates mean for different financial strategies in 2019.

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Key Discussion Points & Insights

1. Federal Reserve Rate Hike and Policy Adjustments

• [00:20-00:58] The Fed raised rates by 0.25% to a range of 2.25%–2.5%.
• Fed Chair Jerome Powell signals fewer hikes than previously predicted:

  “Many FOMC participants had expected that economic conditions would likely call for about three more rate increases in 2019. We have brought that down a bit…now think it is more likely…two interest rate increases over the course of next year.” — Jerome Powell, 00:43

2. Investor Confusion and Market Reaction

• [01:20-02:29] Greg Peters notes mixed signals from the Fed, saying their statement and projections were “really quite confusing," which the markets immediately reflected with a steep drop.
• The contradiction of a so-called “dovish hike” left investors unsure how to react:

  “The whole notion of a dovish hike is akin to jumbo shrimp. It just doesn’t make a lot of sense.” — Greg Peters, 02:36

3. Portfolio Strategy: Defensive Stance and Risk Assessment

• [03:02-04:24] Peters’ main advice for investors is to become more defensive given increased risks and volatility:
  • Credit spreads have widened, suggesting greater reward potential, but also more risk.
  • The risk-reward equation is “better than where we started this time last year," but caution is warranted.
  • Higher yields mean investors don’t need to reach as far for returns:

    “Having fixed income in the broader portfolio makes a lot of sense for investors as it’s defensive and it should protect you in times of turbulence.” — Greg Peters, 03:51

4. The New Value of Cash and Short-Term Instruments

• [04:32-05:21] With quantitative tightening (QT) replacing quantitative easing (QE), cash and short-term rates are now more attractive:

  “Cash rates…is very attractive. And so investors can be much more defensive and get paid for it today relative to a couple years ago…Investors don’t have to go at the risk curve. And I think you need to take that signal to heart and become more defensive.” — Greg Peters, 04:32

5. A Better Environment for Savers

• [05:44-06:44] After years of ultra-low rates, savers finally see improved yields:

  “Yields in the more defensive part of the fixed income markets are higher. And I think that is good news for savers…It’s a much, much better environment for savers.” — Greg Peters, 05:44

  • Savers are now “getting enticed to be defensive,” which he says should be heeded.

6. Trends in Fixed Income: Leveraged Loans vs. Bonds

• [06:44-07:57] Peters predicts a shift from floating-rate “leveraged loans” to fixed-rate products among retail investors:

  “I expect to see a continued transition from the retail perspective out of lever loans in the fixed rate product…a trend that I see continuing over the next year or so.” — Greg Peters, 07:29

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Memorable Quotes

• On the Fed’s confusing messaging:

  “Some of the information out of the statement from the dot plot from the press conference really created more confusion than any clarity and the markets have responded in kind.” — Greg Peters, 01:20

• The Impossible Balance:

  “To try to thread that needle is just inherently really difficult. I think we’re set up somewhat for the impossible.” — Greg Peters, 02:36

• Advice for the Road Ahead:

  “The starting place for 2019 is a much better place. At the same time, you have a continued proactive Fed and risks are rising. So I think that means more defensiveness and indeed we are more defensive in our own portfolios.” — Greg Peters, 03:19

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Timestamps for Important Segments

• [00:20] - Introduction & Summary of the Fed’s Rate Hike
• [00:43] - Jerome Powell on 2019 Rate Hike Projections
• [01:20] - Greg Peters on Fed’s Mixed Message & Market Reaction
• [03:02] - Defensive Portfolio Strategies for 2019
• [04:32] - Value of Cash & Short-Term Instruments in New Rate Environment
• [05:44] - Positive Impact for Savers
• [06:44] - Shift from Leveraged Loans to Fixed-Rate Bonds for Retail Investors

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Summary of Advice and Takeaways

• The Fed is signaling fewer rate hikes in 2019 due to market instability, but its messaging has left many investors uncertain.
• Peters recommends becoming more defensive, increasing allocations to fixed income and cash, and appreciating the new value of conservative strategies.
• Savers benefit from rising yields for the first time in a decade.
• Retail investors may increasingly shift out of floating-rate loans into more traditional fixed-rate products as the interest rate environment stabilizes.

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This episode serves as a valuable guide for both investors and savers navigating a changing monetary environment, emphasizing prudence, the new attractiveness of defensive assets, and the importance of reevaluating portfolio risk in light of Federal Reserve actions.

Transcript

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. [e-mail] Washingtonwise.

[B]

With this special Federal Reserve edition of youf Money briefing. I'm J.R. whalen at the Wall Street Journal in New York on Wednesday. And as expected, the Federal Reserve raised interest rates for the fourth time this year. The Fed raised rates a quarter percentage point to a range between 2.25% to 2.5%. But the Fed sees choppy waters ahead. Here's Fed Chairman Jerome Powell.

[C]

Many FOMC participants had expected that economic conditions would likely call for about three more rate increases in 2019. We have brought that down a bit and now think it is more likely that the economy will grow in a way that will call for two interest rate increases over the course of next year.

[B]

So how should investors interpret the Fed's thinking? We're joined by Greg Peters, he's senior portfolio manager at PGIM Fixed Income, to spell out the details for us. So, Greg, the Fed's decision to pare back its plans to raise rates in 2019 is the result of market instability in large part. But how should investors, retail investors and otherwise adjust their portfolios for this?

[D]

I thought the message on Wednesday was really quite confusing as some of the information out of the statement from the DOT plot from the press conference really created more confusion than any clarity and the markets have responded in kind. I think it's very difficult to interpret what the Fed is really trying to portray. However, I do think it is a message of they'll continue to try to raise rates. So they have taken it down from three to two on a median in 2019. Keep in mind that they added a rate hike after the tax cut and the fiscal spending. So they really just reversed that this time around. And so the markets were really looking for more at the same time, the long term dot. So whereas Fed funds out the long term, they also reduced that which is positive. There's some positive elements and there's some negative elements or not so positive elements. And I think that is creating a lot of interpretation confusion from a market standpoint.

[B]

Well, the markets were sort of confused after the Fed statement came out Wednesday afternoon. The market dropped as many as 450 points.

[D]

Well, the whole notion of a dovish hike is akin to jumbo shrimp. It just doesn't make a lot of sense. I think to try to thread that needle is just inherently really difficult. And so I think we're set up somewhat for the impossible. And so I'm not surprised that the markets had a hard time interpreting because quite frankly, it was almost impossible to interpret it in the first place.

[B]

And so for clients at PGIM who are looking at their portfolio and taking time at this time of the year anyway to sort of revisit things or recalibrate things, what's the recommendation for them to navigate this time of Fed movement and instability?

[D]

So I think the big difference year over year is risk reward. And so on one side of the aisle, you have the reward much higher than where we started this time last year, particularly on the credit portfolios. Credit spreads have widened pretty significantly this year. That's a good news, bad news story, clearly. But the starting place for 2019 is a much better place. At the same time, you have a continued proactive Fed and risks are rising. So I think that means more defensiveness and indeed we are more defensive in our own portfolios. And so we are taking our risk down broadly. We actually do think there is value in yields. So if you think about the debate just six months ago, investors were so worried about yield shooting higher. I don't think you have that same concern going forward. And so I think having fixed income in the broader portfolio makes a lot of sense for investors as it's defensive and it should protect you in times of turbulence.

[B]

Having more of a conservative profile to your outlook and the way you're going to set out to 2019, there's a lot of good in that.

[D]

There is the big difference year over year is also the front end or cash. And so cash rates, Libor, however you want to look at it, is very attractive. And so investors can be much more defensive and get paid for it today relative to a couple years ago. This is quantitative easing in reverse. This is qt. And so investors were forced out the risk curve with quantitative easing. Cash was at zero. They had no other choice but to go out and buy real estate stocks, high yield bonds, et cetera. Today that choice is very different. Right. So with rates higher and now quantitative easing turned to quantitative tightening, investors don't have to go at the risk curve. And I think you need to take that signal to heart and become more defensive.

[B]

All right, we'll have more with Greg Peters, senior portfolio manager at PGIM Fixed Income right after this. And we're back with Greg Peters, senior portfolio manager at PGIM Fixed Income, on the special Federal Reserve edition of of your Money Briefing. So, Greg, there is some good news here, especially for those of us with

[D]

savings accounts, there is indeed, and that is yields in the more defensive part of the fixed income markets are higher. And I think that is good news for savers. And so this goes back to this notion where quantitative easing took front end rates down to zero, which made it a really difficult task for savers to actually earn any income. That has reversed. And so I think it's a much, much better environment for savers.

[B]

It's been a long time since we saw an upward trend in savings account interest rates. It's been, what, 10 years?

[D]

It's been since the crisis, which is 10 years. So, yeah, it's been quite some time. And so I think we're in a very different place, obviously, than we were 10 years ago. And I think savers will benefit and they're actually getting enticed to be defensive. And I think that enticement is an important one and investors should take heed.

[B]

Greg, in your role at PGIM Fixed Income, you've seen your clients in bonds and levered loans. Think that'll be changing?

[D]

I think so. On the margin, you've seen a tremendous demand for levered loans on the retail side over the past couple years. A levered loan is basically a form of financing that companies take on in loan form versus a bond form. And post crisis, what you've seen is a lot of lending going through the loan market versus the bond market. A real trend that retail investors have really focused on is this rising rate environment. And so any floating rate type of instrument was really quite desirable from a retail perspective, with rates already moving higher and then kind of fixed rates moving lower and the concern about rates moving higher a lot less. I expect to see a continued transition from the retail perspective out of lever loans in the fixed rate product. And I think that's a trend that does make sense and a trend that I see continuing over the next year or so.

[B]

All right. That is Greg Peters, senior portfolio manager at PGIM Fixed Income. Greg, thanks for being with us.

[D]

Thank you.

[B]

And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. [e-mail] WashingtonWise.