For Citywire + rated David Albrycht, one of the top five managers in the Short/Intermediate Investment Grade Debt sector over the past three years, ‘all eyes will be on the Fed as it takes steps to unwind its balance sheet’ in the second half of this year.
That $4.5 trillion balance sheet comprises mainly treasuries and mortgage-backed securities, and holders of such debt are understandably concerned that prices will collapse if the bonds are sold too quickly.
Bond investors must now watch a different kind of composition too: that of the Fed itself.
Of the seven seats on the Fed’s Board of Governors, three are currently vacant – pending the Senate’s confirmation of president Trump’s first nominee, Randal Quarles. The posts of both chair and vice-chair are also set to expire before the end of 2018. This gives Trump great scope to reshape the Fed and its approach to managing that balance sheet.
‘The current frontrunners for the top job at the Fed seem to be Gary Cohn, Janet Yellen, Kevin Warsh, Glenn Hubbard and John Taylor – and perhaps a whole host of wildcard candidates,’ noted Bricklin Dwyer, senior economist for North America at BNP Paribas. For Dwyer, ‘the odds currently favor Cohn.’
So what would this mean? ‘While there is a limited record of Cohn’s public comments on monetary policy, the available evidence suggests he might be more dovish than Yellen,’ Dwyer said. For example, in 2015, Cohn questioned her for preparing to hike rates while inflation was low.
Dwyer added that, should he become chair, Cohn would in any case be likely to work consensually. ‘Notwithstanding his experience in financial markets, Cohn has relatively little experience with designing a framework to set appropriate monetary policy compared with most of the other FOMC members. While it is possible that Cohn would seek to assert himself, we think it is more likely that he will take a relative back seat, relying on more experienced governors and regional Fed presidents for guidance.’
Indeed, even if she is replaced as chair, Yellen will remain a Fed governor until 2024.
Cohn heads to the Fed
This all suggests the Fed will maintain a dovish tone for the foreseeable future, which would be welcomed by those currently exposed to treasuries and mortgage-backed securities. However, there is a difference of opinion on the appeal of such assets among this category’s premier performers over the past three years.
The Transamerica Short-Term Bond fund, managed by the AAA-rated team of Doug Weih and Glen Kneeland from Aegon USA, has a 14.5% allocation to mortgage-backed securities. Albrycht’s Virtus Newfleet Multi-Sector Short Term Bond fund has 21% in various mortgagebacked security sectors.
On the other hand, the Johnson Institutional Intermediate Bond fund – run by Michael Leisring, Dale Coates and Jason Jackman – has less than 10% in mortgage-backed securities but 21% in treasuries, which barely feature in the Transamerica and Virtus portfolios.
Both treasuries and mortgage-backed securities are minute positions in the Thompson Bond fund – headed by + rated John Thompson, Jason Stephens and James Evans – which instead focuses on corporate bonds and other asset-backed securities.
The BlackRock Allocation Target Shares Series fund, while the best in this sector over the past three years, is only available through BlackRock separately managed accounts.