- Global Investment and Multi-Asset Strategist
Skip to main content
- Funds
- Insights
- Capabilities
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
The US Federal Reserve (Fed) is one of the most influential drivers of global financial markets, so its monetary policy decisions and actions are obviously critically important. Sometimes, however, the market implications may not be as clear-cut as they might seem.
For example, conventional wisdom tells us that as interest rates rise, existing bonds decline in value. But today’s macro environment is more complex than this simple rule because of the current mix of stubbornly high inflation, weakening economic growth, and a not-so-remote risk of recession. Against this backdrop, I believe higher-quality, long-duration fixed income assets may prove resilient even if the Fed keeps raising short-term interest rates for many months to come.
The Fed hiked rates by 75-basis points (bps) at its July 27, 2022 FOMC meeting, as widely expected. By contrast, the Fed’s 75-bp rate hike in June overshot expectations for a 50-bp increase. However, I would argue that the central bank’s “surprise” move in June actually lagged the latest available US inflation data, as it came after an eye-popping headline Consumer Price Index (CPI) reading of 9.1% and a spike in consumer inflation expectations. The takeaway? Neither the market nor the Fed has a crystal ball but if past is any prologue, it is quite possible that the Fed will continue to follow the markets (based on incoming data), not lead them. But that’s not necessarily bad news for bondholders with longer-term investment horizons.
Interestingly, while fed funds rate futures contracts are signaling that the market believes the Fed’s terminal rate for 2022 will be around 3.25%, December 2023 futures contracts are currently trading closer to 2.75%, suggesting a belief that the Fed will reverse course and begin cutting rates by mid-2023 (Figure 1). Optimistic though it may be, if that forecast is indeed correct, it would certainly make a good case for owning US duration — particularly longer-duration, higher-quality bonds. Of course, the market could well be wrong.
But even if the market is wrong, I think the Fed is more likely to hike rates aggressively rather than too timidly. (In the FOMC press conference following the latest 75-bp hike, Fed Chair Powell commented that “doing too little raises the cost if you don't deal with it in the near term.”) In that case, I believe longer-term bond yields will fall as investors foreshadow more meaningful economic slowing in response to Fed tightening. We’ve already seen some early evidence that the US economy is feeling negative impacts from the Fed’s intense focus on “breaking inflation’s back,” even at the expense of growth:
The risk is that the Fed could back off from policy tightening in the face of weak growth, even while high inflation persists. In that case, I think the market would question the Fed’s credibility and signal as much with higher long-term bond yields — not a chance the Fed is willing to take, in my view.
Impact measurement and management: addressing key challenges
Continue readingDecoding impact expectations: best practices for impact investors and companies
Continue readingSecuritized credit: Normalizing, decelerating, or falling off a cliff?
Continue readingRate relief: Fed cuts half point, but says “economy is strong”
Continue readingThe real issue on rate cuts? Keep your eyes on the dot (plot)
Continue readingURL References
Related Insights
Stay up to date with the latest market insights and our point of view.
Weekly Market Update
What do you need to know about the markets this week? Tune in to Paul Skinner's weekly market update for the lowdown on where the markets are and what investors should keep their eye on this week.
Impact measurement and management: addressing key challenges
Our IMM practice leader describes common impact investing challenges and suggests ways to overcome them.
Decoding impact expectations: best practices for impact investors and companies
We share three recommendations each for impact investors and companies to help them better understand and manage each other's expectations.
Securitized credit: Normalizing, decelerating, or falling off a cliff?
Our experts offer their views on the current conditions and outlook for the securitized credit market.
Rate relief: Fed cuts half point, but says “economy is strong”
Our expert explains the Fed's bold rate cut and some key takeaways for investors.
Monthly Market Review — August 2024
A monthly update on equity, fixed income, currency, and commodity markets.
The real issue on rate cuts? Keep your eyes on the dot (plot)
Keep your eyes on the Fed's 2025 dot plot. The real story is where policy rates are headed, not just the next rate cut.
Extra credit for corporate plans: Advanced topics in LDI implementation
To help corporate DB plans refine their liability-hedging strategies, members of our LDI Team take a deep dive on 3 key liability risks and offer ideas to help improve the design of hedging portfolios.
Picture this: Our forecast in 7 charts
What should investors expect for the remainder of 2024? View a visual summary of our Investment Outlook in seven compelling charts.
What the yen carry trade unwind could mean for markets and the Fed
Brij Khurana explains why market participants are likely underestimating how foreign ownership of US assets could constrain the pace and magnitude of the Fed’s cutting cycle.
Four investment perspectives amid a pivotal US election
How can investors reposition portfolios for a pivotal but highly unpredictable US elections? Nick Samouilhan explores potential avenues in conversation with three leading portfolio managers.
URL References
Related Insights
Monthly Market Review — August 2024
Continue readingBy
Brett Hinds
Jameson Dunn