We’ve written a lot about how there are, to our mind, essentially two strategies for rates.
Firstly, we look back at the 2018 cycle, when the Fed raised rates to ~2.5%, and, the economy slowed sharply, inflation fell, and the Fed was forced back down to ~1%.
Along came the pandemic, and the fed funds rate went to zero.
So, the point is; it’s very difficult to see why we would have a fed funds rate closer to 5%, for the next few years.
That suggests they’ll be cutting, and, if they’ve overcooked things, potentially a recession.
Back to our view on rates.
You can stay predominantly short duration, largely floating rate exposures, and get good yields. You’ll miss out of course if the “overcooked” part is correct, as duration will likely produce capital gains.
However, time is probably on your side. The Fed is still hiking, and you can usually start to rotate duration when the Fed actually begins to cut, and still collect a lot of yield + duration on offer in say intermediate treasuries.
Or, you can hand-wave away the precise timing, decide that 10s at 3.5% is good enough, and (ideally!) enjoy the benefit of negative correlation in the short run (assuming it is there).
In our view, either is fine.
Maybe the main point of the note is to remind ourselves that in 2018 the Fed tried to lift off from the zero lower bound, caused a mini-manufacturing recession, and had to reverse track, as did the ECB.
If the pervasive forces that were in play then (a lower r*, the natural rate of interest consistent with stable inflation and an economy producing at potential output) are still with us now, then there is no way the fed funds stays near 4-moving-towards-5%.
That’s why the market is pricing a 150bps worth of cuts across the back end of the curve.
Important Information: This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only.
This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.
Please note that past performance is not a reliable indicator of future performance.
General Advice Warning: This document has been prepared without taking into account your objectives, financial situation or needs, and therefore you should consider its appropriateness, having regard to your objectives, financial situation and needs. Before making any decision about whether to acquire a financial product, you should obtain and read the relevant Product Disclosure Statement (PDS) or Investor Directed Portfolio Service Guide (IDPS Guide) and consider talking to a financial adviser.
Taxation warning: Any taxation considerations are general and based on present taxation laws and may be subject to change. Aequitas is not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and investors should seek tax advice from a registered tax agent or a registered tax (financial) adviser if they intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.