Kames' McNeill: Central Banks Will Revert To QE Very Quickly In The Next Downturn

McNeill warned a spike in global real interest rates, which have been on a downward trend since the 1980s, would cause a repricing across all asset classes, not just fixed income.

"In terms of asset prices, global real interest rates is the key factor," he said. "Real rates could pick up this year which would be the real danger for all markets."

Once we reach the end of the business cycle and markets move downwards, the head of rates said the Federal Reserve would be forced to return to its quantitative easing (QE) programmes as central banks will not have interest rate levers like during the Global Financial Crisis of 2008.

Managers warn unwinding European QE could burst 'the mother of all bubbles'

He predicted interest rates in the US would rise to a maximum of 3%, which is well below the 5% the Fed has historically reduced rates by in a market crash.

"There will be more rate rises in the US but the peak in US interest rates will be much lower.

"When we get to that peak, the market will start to concentrate on the number of bullets the Fed has to deal with the downturn when we get there.

"The Fed will not have 5% worth of [interest rate] bullets," he said. "When there are less bullets, central banks will revert to QE very quickly."

However, McNeill said in the event of a crash, which could be as far as 18 months away, the Fed has room to manoeuvre with its $4.5trn balance sheet.

He compared it to the Bank of Japan's balance sheet, which is the equivalent to 97% of the country's GDP while the Fed's only totals 23% of US GDP.

"The starting point of the next downturn will lead to balance sheet expansion in the US. The BoJ shows the Fed's starting point is not that extreme," he said.

Extreme pricing

Due to expensive valuations globally, McNeill said he was looking to identify areas where market pricing had become extreme relative to other assets.

He gave the example of where the market priced European interest rates to be negative for just as long as Swiss rates, even though Swiss rates has had negative deposit rates for years.

Kames' McNeill: Markets are too worried about the wrong thing

"The European economy is doing fantastically well as it has added €2trn asset purchases since 2015. Our view was that the relative market position was wrong as European rates could move away from minus 40 basis points.

"The challenge we have is our starting point. It is like not 2009 and early 2016 when everything fell, instead everything looks expensive."

According to FE, the £120m Kames Absolute Return Bond Global fund has returned 1.4% over the past year versus -0.1% for the FO Absolute Return sector, as at 17 January. McNeill estimated it would return between 2% and 2.5% this year.