The strength of the dollar, the best performer among major currencies in the past year, is unlikely to discourage the Federal Reserve from raising interest rates in 2015, according to Pacific Investment Management Co.
Pimco, one of the world’s biggest bond managers, expects the Fed to increase the official rate for the first time since 2006 in September as economic growth accelerates, said Andrew Balls, chief investment officer for global fixed income at the company, which oversees about $1.6 trillion. Separately, he said Pimco has reduced some of its German bond holdings.
“We don’t see any reason why the gradual grind higher of the dollar will worry the Fed excessively as long as it’s consistent with the fundamentals,” Balls said in an interview in London. “The dollar’s long-term valuation on a trade-weighted basis is not completely out of whack.”
The dollar’s trade-weighted index has risen to 116.1 from this year’s low at 111.2 in January. That compared with its 15-year average of 109.2, according to data compiled by Bloomberg. The greenback strengthened about 18 percent with respect to nine other developed-market currencies, Bloomberg Correlation-Weighted Currency Indexes show.
While Newport Beach, California-based Pimco expects the Fed to raise the benchmark rate gradually until it reaches 2 to 2.5 percent, Balls said the market has not adequately priced in the risk of higher interest rates. The company is cautious on duration in bond markets, he said. Duration measures a bond’s sensitivity to changes in yields.
“As it gets closer to the actual start of the Fed’s rate-hike cycle, there is the potential for investors to re-price their expectations and those who thought the Fed would never raise rates again throw in the towel,” Balls said. “That’s the context in which we think there should be more risk premium into the front end of the curve.”
Pimco, a unit of Germany’s Allianz SE, has cut holdings of German bonds in its global portfolio due to low yields and volatility created by the European Central Bank’s bond-buying program.
“It’s become harder to judge the trade-off between the ECB technicals and underlying fundamentals,” he said. “You could see the ECB buying pushing the prices away from the fundamentals. We are taking a very cautious approach.”
The yield on 10-year Treasuries rose four basis points, or 0.04 percentage point, to 2.42 percent as of 5:08 p.m. London time Tuesday. Earlier it touched 2.45 percent, its highest level this year. Similar-maturity German yields climbed seven basis points to 0.95 percent.
Last week the German yield jumped 36 basis points, the biggest increase since October 1998. The selloff has driven up the yield from its record low of 0.049 percent on April 17.