In the first half of 2024, the impending US election and the Fed’s decision to push off rate cuts certainly made headlines. At times, though, markets hardly seemed to notice. As we move into the second half of 2024, investors are still grappling with some big questions about the policy path ahead and the impact of the election. To help, Head of Multi-Asset Strategy Adam Berger and Macro Strategist Mike Medeiros discussed the interest-rate outlook, some of the most critical election issues, and the asset allocation implications.
Adam: Mike, let’s start with monetary policy, which you, as a member of our Global Macro Strategy Group and Global Bond Team, spend a lot of time thinking about. What’s your take on the interest-rate environment in the US?
Mike: I look at interest rates through two lenses. The first is structural and it’s based on my 12 to 24 month outlook for slower-moving factors such as trend growth in the economy, the average inflation rate, inflation volatility, and fiscal policy. Currently, those factors together suggest that while we’ve had a pretty material selloff in the bond market over the last three years, it’s not done yet. In fact, to get inflation down to 2% on a sustainable basis, I think we need an even greater level of restrictiveness from the bond market, with the 10-year Treasury yield closer to 6% or 7%. For me, that will be a very important anchor point to watch for in the battle against inflation over the next one to two years.
The second lens I use when it comes to interest rates is the cyclical backdrop. I am always looking for alignment between structure and cycle, which is when markets tend to trend. When we don’t have alignment, markets tend to be more rangebound. That’s exactly what we’ve seen in the bond market over the last 18 months — it’s been a wide, violent range because those structural forces are in place but there are cyclical headwinds. Growth is below trend, the unemployment rate is up more than half a percent off the trough, and inflation, while still elevated, is easing. Looking at the Fed’s forecast through the end of this year, I think unemployment will end up higher than their 4% projection — I’d say closer to 4.5%. I also think their inflation forecast of 2.8% for the core PCE may be too high.
Since the 10-year yield peaked at 5% about nine months ago, the bond market has been more engaged with these cyclical headwinds. It’s been consistent with a soft landing, and I think that’s still coming through. To clear some of the cyclical valuation gaps for the bond market, that would be consistent with 10-year yields closer to 3.75%. So, I think we’ll still have that tension in the short term, between now and the election, which means yields will likely continue to grind lower. But I’m very much still watching for that alignment between structure and cycle, so that we can position portfolios for it when the time comes.
Adam: What will you be watching for in the second half of the year when it comes to the Fed’s next steps?
Mike: For the Fed, it’s really about their dual mandate. I think the bar for a dovish outcome relative to their current forecast is pretty low. The Fed forecasted just one rate cut in its updated projections at the June FOMC meeting. In the scenario I described earlier, where core inflation is closer to 2.5% and the unemployment rate is closer to 4.5%, I’d expect the Fed to cut rates two to three times this year and the market to price in more cuts for 2025. But the outlook for rates could be altered meaningfully by the election outcome.
Adam: That’s a good segue to the election. I sometimes hear from investors that elections haven’t mattered much for the economy or markets historically speaking. Do you think this one matters?
Mike: Yes, I’m completely on the other side of that argument. Elections are enormously important, particularly as it relates to fiscal policy. From a bond market perspective, even midterm elections are critical. The bond bear markets of 1994, 2018, and 2022 ended within a week or so of the midterm elections, and all three of those elections represented shifts from full control by one party to divided government. Bond markets tend to love divided government and hate full control because of the fiscal implications.
So, I think the 2024 election will have monumental implications, and I would highlight four key areas where there’s a real contrast between the parties: