Globally the financial world remains focussed on Janet Yellen, Chair of the Board of Governors of the Federal Reserve (the Fed), as she continues to suggest that the Fed will increase interest rates in the US at some stage later this year. As shown below in chart 6 the market is now pricing in a much higher expectation of rates rising in December versus September this year.
In chart 7, the Fed dot chart, which shows each US Federal Open Market Committee (FOMC) members views on where they feel interest rates are heading that are all predicting rates will increase into the end of 2015, and increase further over the next few years. The red line on chart 6 is the markets expectations of what will they are pricing in with regard to rate increases. As you will note there is a large difference between market and the average FOMC expectations, and as such we may see increased volatility in the fixed interest market if the committee do commence tightening in next month instead of the end of the year.
Chart 6 – Probability of Fed rate hike
Chart 7 – The Fed Dot Chart
Loss of diversification
One of the more disturbing market issues we have been watching over the past 6 months has been the reduction in diversification benefits between bonds and shares. Under normal market condition we expect bonds to do well when shares are falling and vice versa. As shown in the table below, as all asset prices around the world are all pushed higher in the hunt for yield, shares and bonds have started to become much more correlated, meaning they are moving in a similar cycle, and hence we can expect to see this correlation hold should the share and/or bond markets suffer losses.
Chart 8 – Bond/Equity Correlation