By Jeffrey Hibbeler, Director of Portfolio Management & Senior Portfolio Manager
As we approach the end of the year, the financial markets remain closely attuned to the Federal Reserve's monetary policy. Following the last Federal Open Market Committee (FOMC) meeting, a new cutting cycle was initiated, marking the beginning of the Federal Reserve’s (Fed) policy normalization. Here, we provide an analysis ahead of next week’s meeting.
In September, the Fed lowered interest rates by 50 basis points,1 signaling a shift from what has been characterized as a restrictive policy stance. Clearly, the central bank took an assertive start, and now the question on many investors' minds is, where do we go from here? The expectation is that the Fed is looking to front-load rate cuts somewhat to ease restrictive conditions, before gradually moving the policy rate to a neutral level. This shift reflects the mixed, yet generally supportive economic indicators we are seeing, and relatively balanced risks to the Fed’s employment and inflation mandates.
For starters, the labor market has cooled from previously tight conditions and, while inflation is trending downward, progress toward the Fed's target has slowed. Financial and credit conditions are holding strong, supporting corporate profits, as well as fiscal deficits that are misaligned with the current economic cycle.2 However, there remains a risk of inflation resurgence, which could alter the Fed’s pace or scope of rate cuts.
The burden of proof now lies on economic data to dictate the pace of the Fed's cutting strategy. Uncertainties about when we might see monetary normalization, in addition to election outcomes, are expected to lead to in-range market volatility. Nevertheless, the onset of the Fed's cutting cycle should provide support to the fixed-income market.
Currently, market yields are relatively attractive, with real (inflation-adjusted) yields maintaining a solidly positive stance. Performance in the third quarter demonstrated the total return potential of intermediate bonds compared to that of cash. As the yield curve steepens further, cash loses its allure relative to longer-dated fixed income securities. Over a long-term horizon, we believe that an intermediate maturity fixed income strategy will prove more beneficial in a diversified portfolio than that of cash or shorter-dated securities, which may have been substituted for traditional fixed income.
Looking ahead, our base case anticipates a 25 basis point cut at next week’s meeting. This perspective is shaped by continuous assessments of economic indicators and market reactions, which do not move in one direction as we know. As we continue to navigate these changing conditions, investors should stay attuned to shifts in economic indicators and Fed actions.
Staying informed and flexible will be crucial in adapting to the ever-evolving financial landscape. As always, we are here to assist in understanding these developments and adjusting portfolios to align with emerging opportunities and risks. Please contact your Exencial advisor with any questions.
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