Year of the Rat reflections: The Fed’s rate cuts and standout assets

AsianInvestor looks back on our third and fourth Chinese New Year predictions from 2020: what the Federal Reserve did with rates and the best and worst-performing assets.
Year of the Rat reflections: The Fed’s rate cuts and standout assets

At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about economic, political and financial developments that are likely to have an impact on the way institutional investors allocate their funds. And then, one year later, we revisit these forecasts to see how well we did.

Our second and third Year of the Rat forecasts focused on whether the US Federal Reserve would cut interest rates, and which assets were set to perform best – and worst.   

Will the Fed cut interest rates? 
Answer: No (unless the US economy worsens)

Verdict: Correct

As we noted a year ago, all signs in early 2020 indicated that the Federal Reserve intended to pause any efforts to shift their interest rates for the year. On January 29, the US central bank held its first policy meeting of the year, which resulted in a unanimous decision to maintain the key fed funds rate in a range of 1.5% to 1.75%. 

Those plans were upended in a matter of weeks, as the Covid-19 pandemic spread into the US, infection rates skyrocketed and states began locking down. Economic activity plunged and fears surged of a financial calamity on the back of a health crisis. 

To its credit (and as we predicted) Fed chairman Jay Powell and his colleagues were quick to realise the size of the problem and the need to respond forcefully, by cutting rates. Indeed, the bank acted about as robustly as it could, announcing on March 15 it was cutting the benchmark fed funds rate to a range of zero to 25 basis points.

In addition, the central bank pumped liquidity into the financial system and made clear it would offer banks whatever they needed to remain solvent, in a transparent effort to install confidence in the banking system. 

It worked. While 2020 caused many stresses on the US economy there were never any serious fears of a run on the banks or a credit crunch due to a lack of confidence. A lot of credit should go to Powell and his associates in the Fed, who moved quickly and decisively to bolster the foundations of the US monetary system. 

The overnight lending rate remains at the same range that it originally established today, and it appears unlikely to change any time soon, unless there are rapid indications of a return to economic growth and signs of growing inflation. 

What will be the best and worst-performing assets? 
Answer: Best - emerging market equities and bonds; UK equities 
Worst - developed market equities; European bonds

Verdict: Incorrect 

The financial markets of 2020 endured such a shift in sentiment as a result of Covid-19, that it's little surprise that our breezy assumptions of a year ago proved to be wide of the mark. 

In January 2020, some equity valuations were looking frothy and potentially ready for a correction, particularly in the US, while the lingering minimal rate levels of many countries but especially those in the European Union left performance looking unlikely. Meanwhile emerging markets appeared to be areas that were primed to enjoy an influx in investor attention as they sought yields, and UK stocks also looked like the potential beneficiary of low expectations.

The impact of the pandemic threw immediate curve-balls at all financial market predictions. And yet, following a six week period of pronounced volatility in March and early April, investor sentiment began to improve as it became clear the sky would not fall upon the financial markets (courtesy in large part of rapid and vigorous actions by the US Federal Reserve and other central banks – see above reflection) . 

The S&P 500 index ended rising by 16.3% for the full year of 2020, driven by the likes of software and internet retail stocks, despite the major drop in March

What followed was a strange situation, in which corporate bonds and stocks that had been hamered began to improve in valuation – unless they were in directly impacted sectors such as retail consumption, travel or entertainment. 

In the end, the S&P 500 index ended rising by 16.3% for the full year of 2020, driven by the likes of software and internet retail stocks, despite the major drop in March. It was hardly the poor performance we envisaged.

Emerging market stocks also shone, but by far less than investors would have expected in early 2020. The MSCI Emerging Markets index rose by 18.31% across the full year. The world's best-performing stock market? South Korea, whose Kospi benchmark index recorded a 30.8% return for the year, and shot up by 90% from the lows of March.

European bonds didn't greatly impress, as we had anticipated. But they were not a bad investment by any means; the ICE BofA Euro Large Cap Index returned 4% for the year, for example.

Meanwhile UK equities proved a flop; the FTSE 100 dropped 15.24% during 2020. The mixture of a terrible response to the pandemic and concerns about the increasing antagonism between the UK government and the European Union over post-Brexit trade served to hurt the country's stock prospects. 

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