The Federal Reserve has made a policy mistake, according to ETF Securities

Apr 19th, 2016 | By | Category: Commodities

The US Federal Reserve has made a policy mistake by failing to further raise interest rates thus far in 2016, according to exchange-traded fund provider ETF Securities.

The Federal Reserve has made a policy mistake, according to ETF Securities

James Butterfill, Head of Research and Investment Strategy at ETF Securities.

According to the firm’s latest tri-annual outlook report, after raising rates for the first time in nine years, the Fed has begun to bow to market tantrums. While domestic fundamentals grow increasingly stronger (the labour market looks increasingly robust and inflationary pressures appear to be stepping up), ETF Securities believes the Fed’s reluctance to move too far from other central banks that are still in easing mode is feeding further volatility into the market.

According to the research report: “Although uncertainty is likely to be a consistent element within the financial landscape, the US recovery will continue in 2016. However, it seems that now the Fed is responding to asset price volatility and external factors rather than its mandated combination of full employment and price stability. Greater policy uncertainty could be feeding market volatility and generating a self-fulfilling cycle. As a result, volatility will remain until US monetary policy becomes more predictable.”

James Butterfill, Head of Research and Investment Strategy at ETF Securities, commented in a statement: “The risk of waiting too long to raise rates is greater uncertainty. Such a situation seems circular, with markets fretting over Fed decisions and the Fed concerning themselves with market volatility – an issue outside the scope of its mandate.”

Buttefill also commented on how the potential misstep may impact future policy decisions at the Fed. “Real GDP trends indicate that the pace of US economic growth is solid. While the growth path of real GDP is not as strong as pre-crisis levels, there is no evidence of a slowdown. Such a growth path warrants tighter monetary policy. Without a monetary check on inflationary pressures, even a gradual one, expectations threaten to become unanchored, something that only aggressive rate hikes can then cure. We believe that the current guidance on rate hikes will be insufficient to rein in prices and could lead to the Fed having to tighten more aggressively later in the cycle. This could lead to further unintended consequences.”

Another key trend that the report highlighted was that a global economic recovery is likely to provide a tailwind for industrial precious metals such as silver, platinum and palladium. Although all three metals have been caught up in an extended bear market since 2011, reflecting moderating economic growth in China, silver, platinum and palladium have started to recover this year, rising 14%, 11% and 7%, respectively as of 25 March 2016. ETF Securities believes demand for these metals will likely continue as China’s industrial output appears to have found a base.

All three metals have also been in a supply deficit during the past three years. Over 80% of platinum and nearly 40% of palladium are produced in South Africa – as the Rand depreciation abates and miners cut back on activity, ETF Securities expects supply deficits for these metals will likely grow.

Investors may wish to consider the following ETPs provided by ETF Securities: the ETFS Physical Silver ETP (PHAG), ETFS Physical Platinum ETP (PHPT) and the ETFS Physical Palladium ETP (PHPD).

Turning to gold, ETF Securities notes that current central bank policies is acting as a supportive influence on gold. The Swedish Riksbank, Danish National Bank, Swiss National Bank, Bank of Japan, and the European Central Bank have adopted policies of negative interest rates. Negative interest rates, whether in nominal or real terms, may be positive for gold prices as it decreases the relative attractiveness of yield-paying securities compared to gold which does not pay any income. By adopting the unusual position of negative interest rates, some analysts have also suggested these central banks are fuelling uncertainty in the markets which may further boost gold through its status as a safe haven asset. Lastly, gold investments have historically provided a good inflation hedge and with inflation ticking upwards in the US, ETF Securities believes pressure will be on the yellow metal.

ETF Securities provide the ETFS Physical Gold ETP (PHAU) for investors seeking a bullish exposure to the gold price.

While emerging markets have been in the doldrums for some time, ETF Securities believes pessimism around emerging market bonds is overdone. Investors are being overcompensated for emerging market credit risk and this may present a buying opportunity.

An upturn in emerging market bond demand will also have a positive impact on the respective currencies of the countries in question. On the premise that investor flows search for returns within high growth and low inflation economies, ETF Securities thinks emerging Asian currencies appear to be the best placed for strength in 2016. That being said, from a valuation perspective, ETF Securities favours emerging European countries as they have relatively low levels of debt compared to their Latin American and Asian counterparts.

ETF Securities offers the ETFS Lombard Odier IM Emerging Market Local Government Bond Fundamental GO UCITS ETF (LOCL) for those investors seeking emerging markets fixed income exposure. The fund provides long-only exposure to the debt of emerging markets, whose weights are determined according to Lombard Odier’s proprietary fundamental weighting methodology, which uses fundamental factors to assess issuers’ creditworthiness and identify those believed to be best placed to repay their debt.

Mark Weeks, CEO at ETF Securities, added: “As reported in the Outlook, we believe that despite recent market turmoil, compelling opportunities continue to exist for investors,” said Weeks. “We continue to work hard, often in partnership with leading third parties, to make these opportunities across commodities, FX, thematic equities and fundamental fixed income available to all European investors.”

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