Investors are giving up on timing a rate hike and dumping funds
The IMF slashed forecasting for US economic growth last Thursday and sent a call through the ranks towards the Federal Reserve: hold off on rate increases—the first in nearly a decade until next year.
During the annual IMF review of the US economy, the discussion revolved around a series of negative shocks—the strengthening dollar, bad weather, and labor disputes sapped momentum for job creation and economic expansion. These events prompted them to downgrade the growth expectations for the year to 2.5%– down from April at 3.1%
The labor disputes on the West Coast ports, combined with the collapse of oil sector investment while energy prices plummeted drug down growth in Q1 of 2014. Slack continued in the labor market as well, with long-term unemployment and high levels of part-time work holding back growth.
The dollar has grown exponentially against other major currencies in the last 12 months as the US economy got stronger, prompting other central banks to rev up easy money policies and is holding back growth and job creation. The IMF’s analysis shows that the currency is already moderately overvalued, and further marking appreciation of the dollar could very well harm the US economy.
These realities led to the IMF recommending and petitioning the Federal Reserve to defer its planned rate increase until Q1 2016.
This caused problems and uncertainty in the funds market, specifically in the bank-loan category. There’s nothing inherently wrong in the category, but it appears that investors lost interest in the entire category as interest rate hikes didn’t materialize as expected. Since these rates reset based on a spread focusing over LIBOR, bank loans are one of the few types of bond investment that are insensitive to fluctuations in interest-rates. Investors had flocked to these funds during 2013, leading to the category picking up more than $61B that year and nearly doubling in size. This interest rate hiccup was short lived—with rates trending downward in 2014. This prompted an exodus from the category that persists into Q2 2015. All in all, investors yanked more than $30B from the category through May of this year, forcing some bank-loan funds to turn to lines of credit to meet their investor redemptions.
So the takeaway for investment managers? Predicting the direction of rate adjustments can be excruciatingly difficult. Bank loans might appear to be a good decision when faced with rising rates, but floating rate loans’ credit delicacy and low-liquidity nature makes them a specialized asset class at best. Performance is likely to correlate to the strength of the equity market.