The post-COVID world, with Capital’s Night Watch
February 8, 2021
American Funds video transcript: “Fed’s interest rate pivot brings new risks”
Will McKenna: I know credit risk has been a theme that you and the team have been talking about for some time. And perhaps investors were more focused on interest rate risk and not enough on credit risk. Talk more about that. Where do you see that today? Obviously, in corporate bonds and in high yield. Are we still at that kind of cautious place?
Mike Gitlin: Yeah. If you look back at 2018, what we heard all the time from folks out there was that they worried about interest rate risk. That rates were going up, that the Fed was hiking. And now, we have the opposite, where if you look at how the market's pricing and what may happen with the Fed, the market's now pricing in two cuts for the rest of 2019, and then two cuts in 2020.
So just six, eight months ago, there were three hikes expected and now four cuts in the next two years. So there's a dramatic switch in terms of how people are perceiving interest rate risk. We've been long duration, so our view has been we didn't worry as much as some others on interest rate risk. But we are worried on credit risk. When you look at investment-grade and high-yield spreads, and they're basically on the border of the richest quartile or the second quartile of richness, we get worried from a valuation standpoint.
Will McKenna: And this will tie into this big change in bond land around Morningstar splitting that intermediate category into core, core-plus. Pretty connected into this topic, I believe.
Mike Gitlin: It sure is.
Will McKenna: You kind of referenced it, but we have been talking about the shift from QE to QT, and maybe its shift back. But tell me, what's your view on that now? Is something fundamentally changed? Are we on a different path altogether, or is it a pause in the path, or —
Mike Gitlin: It's a different path altogether. You know, the Fed had made some progress in reducing its balance sheet. So at its peak it was about $4.5 trillion. Over the last few years, it's now come down to $3.7 trillion. But in September, they're stopping. So the balance sheet will pause at about $3.7 trillion. So what we saw as QT is effectively ending. And that's the Fed acknowledging some slower growth around the world that Darrell referenced, and also, quite frankly, a view that the equity market risk was relatively high. When we look at the Fed pivot, there are lots of folks who thought it might be related to the executive branch, or the President. And in actuality, it was more about global growth, in our view, and the equity market 20% decline we saw in the fourth quarter of 2018.
Past results are not predictive of results in future periods.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
The return of principal for bond funds and for funds with significant underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings. Lower rated bonds are subject to greater fluctuations in value and risk of loss of income and principal than higher rated bonds.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
This content developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.
American Funds Distributors, Inc., member FINRA.
Any reference to a company, product or service does not constitute endorsement or recommendation for purchase and should not be considered investment advice.
© 2019 Capital Group. All rights reserved.