As the US Federal Reserve ploughs ahead with plans to raise rates by the end of the year, Societe Generale’s analysts have set out tweaks investors should consider making to their portfolios.
The French bank has warned that some assets are better positioned than others for a rate hike—and pointed to where there could still be value to be had before D-Day.
“Higher rates are in turn leading to a stronger US dollar, which puts earnings under pressure.”
The team believes, like many in the market, that September is the most likely time for the hike, which means economic momentum should continue through this third quarter.
“To price a September hike, the 10-year US treasury yield would likely need to be in the 2.5% to 2.6% range, according to our rates strategists,” the bank said. “In the short term, there is therefore still some room for the curve to steepen, but the opportunity will quickly dissipate when hike probability increases, as short-term rates are likely to come under increasing pressure.”
Assets to hunt out include US banking stocks, Societe Generale analysts said, as they have outperformed by 8% in the last 12 months and this is expected to continue. A recovering economy should fuel demand for residential and commercial mortgages, further strengthening the sector.
However, this upwards movement is not likely to be reflected in the wider US market, the analysts warned.
“Higher rates are in turn leading to a stronger US dollar, which puts earnings under pressure,” Societe Generale said. “Market breadth has deteriorated, and without a strong improvement in earnings, the S&P 500 will struggle to post strong returns in the next quarters.”
Another area to avoid, at least in the short term, is emerging markets, the bank said. Combined with a slowdown in China, which is impacting commodities markets, the economies in this enlarged sector will feel considerable backlash in the second quarter of the year.
Several emerging market currencies “are therefore likely to depreciate further ahead of the Fed tightening cycle, as the risk of capital outflows increases,” the bank said.
“Our emerging market strategists recommend maintaining short emerging market FX positions against the dollar, and curve steepening trades in local rates. However, when the Fed finally hikes, a relief rally could ensue once policy uncertainty is removed, as valuations have started to become less demanding,” the analysts said.
Even so, a smooth transition is not guaranteed, the bank said, and a determining factor to monitor will be the magnitude of US rate movements.
Related: Ray Dalio: We’re Not Bearish on China Yet; Fed Rate Rise ‘Not the Only Show in Town’; What Are You Hedging?