UBS recommends three investment areas as Fed rate hike odds climb to 60%

As uncertainty mounts ahead of the Federal Reserve's September meeting, UBS has singled out three areas for investment and scrapped a bond recommendation.

According to UBS strategists, the central issue is not the decision itself but the economic context. Market expectations have shifted dramatically in recent weeks.

Why the Backdrop Matters More Than the Meeting

At the Jackson Hole symposium, Fed Chair Kevin Warsh cautioned about persistent inflation.

“You may have read in the July minutes…Labor markets were stable, and output was solid. But inflation remained too high. A good majority of my colleagues and I thought the wiser course was to await new information in the intermeeting period…And we expressed our joint readiness to act as circumstances might require,” he said.

The case for a rate move was strengthened by August's jobs report. Nonfarm payrolls increased by 162,000, far exceeding the 55,000 predicted by analysts, and the jobless rate remained at 4.1%.

This was the highest figure since March. Over the past month, market participants have frequently adjusted their expectations.

The CME FedWatch tool indicated a 60.4% chance of a rate increase in September as of Tuesday. The probability rises to 70.9% by October and 85.8% by December.

The FOMC is scheduled to meet on September 15-16. In July, the committee left its target range unchanged at 3.50%-3.75%, with three members voting for an increase.

Strategists under Mark Haefele differentiate between a rate increase motivated by strong growth and one prompted by stubborn inflation.

“A Fed responding to US economic strength is very different from a Fed responding to inflation problems. For portfolios, that distinction matters far more than the next policy meeting,” they stated.

Where UBS Wants the Money to Go

First, UBS recommends buying equity dips as long as earnings outlooks remain solid. The bank maintains its preference for sectors like AI, energy, resources, and longevity in stock allocations.

Second, UBS points to the medium-to-long segment of the yield curve. The recent rise in bond yields has created better entry levels, providing both income and diversification.

Third is gold. UBS views the precious metal as a hedge and diversifier for portfolios, not as a tactical play on the upcoming Fed move.

In the near term, higher real interest rates and a stronger dollar weigh on gold. However, ongoing inflation and fiscal credibility worries could counterbalance those pressures.

Separately, UBS advised clients to trim their dollar holdings given the currency's strength.

“We would no longer recommend that investors lock in yields in short- to medium-duration bonds as an alternative to cash,” UBS added.

The August core CPI report is due on September 11, just four days before the FOMC meeting. That data will challenge the sustainability of the current hawkish repricing.