The worst week in the U.S. stock market in two years and benchmark 10-year Treasury yields hitting four-year highs are prompting fund managers to rethink their allocation plans.
Among their new plays: international bonds, emerging market stocks, and cash. All look poised to gain as investors assess the consequences of more U.S. fiscal stimulus just as the Federal Reserve prepares to raise interest rates to prevent the economy from overheating.
“This is unchartered territory,” said Kirk Hartman, global chief investment officer at Wells Fargo Asset Management.
The turmoil stems from a tug-of-war between monetary and fiscal policies: The Federal Reserve, which is mandated to keep inflation low and stable, and U.S. fiscal policy, which is adding stimulus with a $1.5 trillion Republican-led tax cut and an extra $300 billion over two years in federal spending as the central bank unloads bonds from its balance sheets.
New York Federal Reserve President William Dudley said on Thursday that the central bank may raise interest rates more than three times this year if the U.S. economy continues to expand thanks to “a very large tax cut that’s going to provide additional stimulus.”
Underlying the push outside of U.S. assets is a fear of rising inflation, after years of ultra-loose monetary policy.
Wages rose in January at an annual pace of 2.9 percent, the largest increase since 2009, prompting investors to begin to price in the chance that the Federal Reserve may raise interest rates at least three times this year.
That could push the benchmark 10-year Treasury rate, which sets borrowing costs for loans ranging from autos to mortgages, up to near 4 percent, a level that economists say would dampen economic growth. “We are very conservative today on both stocks and bonds and waiting for better opportunities,” said Matt Watson, a portfolio manager of the $2.7 billion James Balanced Golden Rainbow fund who has been increasing his cash position.
Overall, U.S. fund investors sold $23.9 billion out of the stock market during the week that ended on Wednesday, the largest withdrawal on record, Lipper data showed on Thursday.
U.S.-based inflation-protected bond funds attracted $859 million in the same week, the largest inflows since November 2016, while emerging market stocks brought in $291 million, continuing a streak of positive weekly inflows since the start of the year.
“The risk now is that inflation will rise more sharply, as a result of even looser fiscal policy,” said John Higgins, chief markets economist at Capital Economics.
Rattled by U.S. Fiscal, Monetary Tug-of-War, Investors Start Looking Abroad