(Bloomberg) -- Credit hedges and bearish bets on U.S. stocks are some of the hedges worth considering if the Federal Reserve disappoints equity markets, according to Bank of America Merrill Lynch (NYSE:BAC).
Low volatility across a range of asset classes signals investors may be underpricing risks, with the majority of traders expecting the Fed to lower its key rate on Wednesday, BofA equity-derivatives analysts including Gonzalo Asis and Nitin Saksena said. They recommend owning short-dated protection, in particular, suggesting bearish bets on the iShares iBoxx High-Yield Corporate Bond exchange-traded fund.
The Fed is widely forecast to make the third reduction in interest rates this year. Markets will be watching in particular for the central bank’s future outlook -- whether it seems willing to ease policy further or wants to signal a pause. In addition to the Fed decision, a slew of economic data, including gross domestic product and the monthly jobs report, are also due by the end of this week.
“Puts on emerging-market equities, broad U.S. equity indexes and certain U.S. sectors (largely the most cyclical) are the most attractive to own into Wednesday‘s FOMC decision and a macro-heavy week, while high-yield credit ranks highest among non-equities,“ the analysts wrote in a note Tuesday, using a screen of options expiring Nov. 8.
Emerging-market and European equities may have less downside as they are already unloved by investors, making high-yield credit, which is more heavily owned, the best way to hedge against a Fed disappointment, the strategists said.
The Consumer Discretionary Select Sector SPDR Fund, Technology Select Sector SPDR Fund and Materials Select Sector SPDR Trust would be the best ways to hedge sectors, they said.
