INTEREST RATES UNLIKELY TO RISE FOR TWO YEARS, ACCORDING TO LEGG MASON CIOs

Interest rates will not rise significantly for up to two years despite market expectations that they will move higher in the second half of 2015, according to the CIOs of Legg Mason’s subsidiaries, who between them oversee $693 billion* of assets.
Speaking at Legg Mason’s Investor Day, held in New York City, the CIOs agreed that, while the US Federal Reserve has forecast that benchmark interest rates will top 1% by the end of 2015, the probability is that rates will be lower for longer.
“People shake their heads at rates that seem extraordinarily low, but when you look at the US 10-year rate at 2.5% versus the German 10-year at 1% or the Japanese rate at 0.5%, and many of the rates in Europe, they are much below the US,” said Ken Leech, CIO of Western Asset, one of the world’s leading and largest fixed income managers. “You see why many investors around the world are compelled to invest in the US, so our view is that this path to higher rates and higher inflation is going to take quite some time. That could mean more than 18 to 24 months.”
Leech said that, while he supported the policy response to the 2008 financial crisis, central bank action will be difficult to unwind due to its potential impact on the economy. “The policy response has been necessitated by the enormity of the slack in the global system,” he said. “This was by design and I think that as you pullback from that policy experiment, you have to be really thoughtful, because the optimistic side says the economy is strong enough to take it, but that is a question mark; and I think policymakers are going to be very, very slow to unwind and therefore, we think rates are going to be very, very slow.”
Isaac Souede, CIO of Permal, one of the oldest, at scale asset management firms, with more than 40 years of experience, echoed Leech’s sentiment, highlighting the lack of inflationary pressure in the US.
“China is experiencing a secular long-term slowdown in its economy and there’s an imbalance in commodities because of supply and demand,” he said. “At the same time, Ukraine/Russia has put a strain on Europe, which is certainly deflationary, as is the stronger Dollar, so America is getting a break from an inflation standpoint. When you put it altogether, my view is real interest rates are going to go up, and perhaps have begun to go up looking at the two-year note. However, the other stage rocket for high rates – inflation – is not going to be there, so I think, yes, higher interest rates, but at a very measured pace.”
Chuck Royce, CIO of small-cap specialist Royce Funds, added that many of the Federal Reserve’s moves in recent years “have had a positive impact on small caps, so we are not complaining”. Still, he said quantitative easing unequally benefitted “the inferior company” thanks to the wide availability of funding, particularly high-yield debt. “It has had a profound effect on their ability to survive and prosper,” he said. “Quality companies have been on a relative basis disadvantaged. They did not need balance sheet help or high-yield bonds.”