Insights
Market Insights
Shift in the Tides
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Market Insights
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July 15, 2024
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Shift in the Tides
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July 15, 2024
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Shift in the Tides
Shift in the 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 June. The press release was effectively unchanged aside from a slight modification suggesting that progress reducing inflation has been “modest,” compared to the prior meeting characterization noting “a lack of” further progress. Federal Reserve (Fed) Chair Powell mentioned inflation remains too high, but it has eased over the past 12 months.
The June FOMC meeting included an update of the Fed’s summary of economic projections. The Fed’s dot plot showed officials’ median projection for the benchmark rate at the end of 2024 increased 50 basis points to 5.1% from March. The 2024 median gross domestic product (GDP) growth projection was unchanged at 2.1%. The 2025 GDP growth forecast was also left unchanged. 2024 unemployment rate estimates remained static from March at 4.0%. The 2024 core personal consumption expenditures (PCE) inflation projection increased 20 basis points from the March forecast to 2.8%.
European Central Bank1
The European Central Bank’s (ECB) Governing Council reduced the deposit rate 0.25% to 3.75% at the conclusion of its policy meeting on June 6. The Governing Council noted that based on its outlook for inflation and restrictiveness of policy rates, June was a suitable time to tweak policy after nine months of maintaining peak policy rates. The committee noted price pressures are starting to abate and inflation expectations are falling. Despite this, officials increased inflation forecasts slightly, now anticipating inflation to average 2.5% in 2024 then subsequently declining to 2.2% in 2025.
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 June meeting. Two dissenting members favored decreasing the rate 0.25% to 5.00%. May 12-month headline inflation data declined to 2.0%, which was below March’s 3.2% print, and the MPC noted inflation expectations have continued to “moderate” in the short term. The BoE referenced U.K. GDP growing “more strongly than expected” in the first half of the year, but forecasts indicate a slowing in the second half. Progress has been made on the back of restrictive policy, although BoE members suggested further evidence is needed. The committee remains attentive to incoming data and is prepared to adjust policy “as warranted” to ensure inflation returns sustainably to its 2% target.
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
While data over the past month continues to show progress towards the Fed’s inflation objectives, officials reiterate that they will remain patient and data dependent before easing policy rates. With the Fed likely on the sidelines for the next couple months, rates remain at elevated levels and the futures curve appears to be priced appropriately with one full rate cut by the November FOMC meeting and fewer than two cuts for the remainder of the year. With unconstrained dealer balance sheets and no supply or credit shocks taking place, spreads remain tight in the wholesale funding market. We continue to prefer fixed-rate over floating-rate (or “floaters”) securities, bypassing the higher current yield of floaters to lock in coupons through mid-2025, which can benefit the portfolio when the Fed eventually eases rates. WAM continues to remain elevated versus the peer group due to increased exposure to fixed-rate securities.