Insights
Market Insights
Changing Tides
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Market Insights
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May 15, 2024
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Changing Tides
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May 15, 2024
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Changing Tides
Changing Tides |
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Federal Reserve Board1
The Federal Open Market Committee (FOMC) held the federal funds target rate at its current range of 5.25% to 5.50% in May. Congruent with the higher-for-longer sentiment, Federal Reserve (Fed) Chair Powell downplayed the need to lower rates immediately as the press release noted that there has been a “lack of further progress” toward the 2% inflation target. However, the committee believes employment and inflation objectives have moved into better balance over last 12 months. The FOMC also announced it is slowing the pace of its balance sheet reduction by moving the monthly the cap to $25 billion from $60 billion for Treasury securities. The cap for agency debt and agency mortgage-backed securities remains unchanged at $35 billion per month.
European Central Bank1
The European Central Bank’s (ECB) Governing Council left the deposit rate unchanged at 4.00% at the conclusion of its policy meeting on April 11. The ECB suggested that a rate cut could be on the horizon as its medium-term outlook has been “broadly confirmed.” Food and goods pricing has led to declining inflation while wage growth continues to soften. Sufficiently restrictive rates in the eurozone have kept financial conditions tight and have weighed on demand. President Lagarde confirmed the ECB’s current sentiment toward a rate cut in her press conference, which was a first since the deposit rate peaked at 4.00% in September.
Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to hold the Bank Rate steady at 5.25% at the conclusion of its May meeting. Two dissenting members favored decreasing the rate 0.25% to 5.00%. U.K. gross domestic product is expected to have grown 0.4% in the first quarter while the committee projects 0.2% growth in the second quarter. At 3.2%, March 12-month headline inflation data came in below February’s 3.4% print. BoE members believe inflation will trend toward 2% in the “near term,” ending the year near 2.50% due to “unwinding of energy-related base effects.” However, geopolitical risks remain, which could materially impact oil prices and therefore its inflation projections.
PORTFOLIO STRATEGY
Government/Treasury Strategy
Weighted average maturity (WAM) and weighted average life (WAL) figures were fairly stable month-over-month in the portfolios, as we continued to barbell a conservative approach to floating-rate securities along with laddering in longer-dated, fixed-rate bonds at attractive yields. Specifically, as May brought a signal of patience from the Fed, the 1-year end of the curve reversed some of its deep inversion, making it more attractive and less punitive from a carry standpoint to add some of these positions. We feel these positions offer attractive value once the Fed starts to cut interest rates, as well as offer the added benefit of potentially outperforming if we see a deeper cutting cycle.
Portfolios must balance harvesting the current carry of elevated rates while not being overly exposed to long-dated floating-rate securities given the likelihood of Fed cuts within the next year. We’re being deliberate on the floating-rate exposure we own. We feel that if data turns, it will turn quickly, and attractive fixed-rate options will disappear. Therefore, we have sought to incrementally buy into fixed-rate bonds. We are open to the narrative that rates are likely to remain in a choppy pattern through the year, and over the balance of 2024 we have to remain open to the possibility of one to two rate cuts, as well as a scenario of no rate cuts.
Treasury and agency auctions have continued to be orderly. We believe auction sizes in the shortest tenors will likely decrease through June. We would also note that the 6-week cash management bill has been promoted to a benchmark bill, with an effective date later this year. We have no concerns or issues to raise with respect to T-bill liquidity.
Prime Strategy3
Hawkish comments from Fed officials throughout the month indicated that officials are in no rush to ease monetary policy until they see evidence that inflation is sustainably trending toward their 2% target. As a result, rates remained at elevated levels and the futures curve appears to be priced appropriately, ending the month with the first full rate cut anticipated by the November FOMC meeting and fewer than two cuts total throughout 2024. Spreads remain tight across the short end of the curve, with a lack of supply and dealer balance sheets remaining unconstrained. As a result, the WAL of our portfolios continued to decline, as we patiently wait for a dislocation in pricing before adding risk. We continue to add fixed-rate securities toward the longer end of the curve on the back of sell-offs, locking in fixed yields through the second quarter of 2025, which provide an attractive hedge if the Fed eases sooner or by a larger magnitude than anticipated by the market, while having a more attractive liquidity and roll-down profile compared to its floating-rate equivalents.