Displaying items by tag: fed

Elizabeth O’Brien covered the optimism among bond investors that a change in Fed policy could result in a major rally for the asset class in a Barron’s article. Current fed futures odds show that the market sees a more than 90% chance of the Fed pausing at its next meeting. And given recent inflation and economic data, it’s likely that the Fed has seen sufficient progress to shift its focus to financial stability over combating inflation.

Therefore, it could be an opportune moment to invest in high-quality bonds with longer maturities. These bonds are yielding about 5% which is nearly double what they averaged during the past decade. 

While some believe that the economy is weakening enough to compel the Fed to cut rates by the end of the year, others believe this is a more typical cycle and that the Fed will likely be on hold for an extended period of time. 

Since 1990, the average pause between hiking and cutting cycles has been 10 months. The typical behavior is that fixed income rallied in anticipation of cuts but volatility picks up until the cuts actually begin, leading to a healthy tailwind for the sector. 

Finsum: A major catalyst could be emerging for fixed income given that the market expects the Fed to pivot at its next FOMC meeting in June.

In an article for the Financial Times, Mary McDougall reported on growing investor nervousness regarding junk bonds due to tightening credit and financial conditions. According to the Federal Reserve’s survey of Senior Loan officers about 46% of banks are planning to tighten lending standards given worries about defaults and recent stresses to the banking system. 

Historically as lending standards tighten, it leads to a wider spread between junk bonds and Treasuries, indicating concerns over growing defaults. This can even potentially exacerbate a recession as companies have tougher times accessing capital markets which can affect corporate decisions,leading to belt-tightening and job losses. 

What’s interesting is that many expected that the regional bank failures that began in March would have impacts on spreads and lending. Yet, there hasn’t been an impact yet. In fact, the entire bond complex has been quite strong since these stresses began as many interpreted it as increasing the odds of the Fed pausing rate hikes. 

The Federal Reserve also seems to share these concerns as Chair Powell discussed the possibility of a credit crunch and that it poses one of the major risks to its economic outlook and financial stability. 

Finsum: Despite the Fed’s rate hikes and regional banking concerns, lending and spreads have remained relatively resilient, but some are concerned that this won’t last. 

Category: Wealth Management; 

Keywords: #bonds; #Fed; #fixed income

In an article for AdvisorPerspectives, Edward Perks of Franklin Templeton shared his reasoning for why fixed income should outperform equities in the near term. 

First, he sees that inflation is trending lower, but there still needs to be more progress before the Fed would actually start cutting rates. Further, he acknowledges recent stress in the banking system but doesn’t see it spreading to other sectors and becoming a more significant issue which would force rate cuts. 

This should lead to a positive scenario for fixed income with longer-term rates bending lower, short-term rates plateauing, and inflation gently moving lower. However, he does believe that the economy will keep slowing so that corporate earnings will soften into the second-half of the year and 2024. 

Due to these factors, he recommends a 60/40 allocation with a larger tilt for fixed income over equity. It’s also possible that the allocation could change even more if the economy stumbles into a recession. The firm is particularly bullish on investment grade credit as it offers compelling value with strong upside especially if Franklin Templeton’s base case economic scenario plays out. 

Finsum: Franklin Templeton is quite constructive on fixed income but less so for equities. Here’s why it’s recommending a 60/40 allocation tilted towards bonds.

In an article for MarketWatch, Vivien Chen covered the decline in Treasury yields following the May FOMC meeting. Although the Fed did hike rates, investors were willing to look ahead as it seems increasingly likely that this was the final hike of the cycle. According to Fed fund futures, the market now expects the Fed to begin cutting rates in Q1 of next year.

Recent economic data which continues to show a weakening labor market, decelerating growth, and softening inflation also confirm this narrative. Additionally, many regional banks continue to struggle given the inverted yield curve which many fear could lead to a credit crunch.

At the FOMC press conference, Chair Jerome Powell continued to assess the inflation battle as being a “long way to go” and that the labor market remains “very tight”. Despite Powell’s hawkish tone, fixed income markets were stronger across the board. Odds for no change in the fed funds rate reached a 95% probability. Additionally, the market’s target for the year-end fed funds rate declined slightly to 4.25% which implies a reduction of 75 basis points. 

Finsum: Treasury yields are modestly lower since the Fed’s rate hike. Odds of a pause at the next meeting have also climbed higher.

In an article for Bloomberg, Ye Xie and Liz McCormick discussed how Vanguard’s fixed income ETFs have been major recipients of inflows as investors look to take advantage of higher yields and protect their portfolio from a potential recession later this year.

In March, the funds saw $26 billion of inflows due to the crises at Credit Suisse and Silicon Valley Bank. This was nearly more than last year’s cumulative $31 billion of inflows. 

It’s also an indication that Vanguard’s passive management and indexing strategies will take on even greater significance in the fixed income world as these funds keep growing. In total, Vanguard’s fixed income funds have over $1 trillion in assets. 

It also follows what has happened in equity markets, where passive funds have ballooned in size, and make up the bulk of inflows. In hindsight, the 2008 financial crisis and subsequent few years seem to have been the trigger for equity investors favoring passive funds over active ones due to the strong outperformance of indexes. 

Similarly, 2022 was the biggest rout for bonds in decades due to inflation and a hawkish Federal Reserve. This also has led to investors rethinking allocations, and one outcome has been the growth of passive over active. 

Finsum: Similar to what happened in equities over the last decade, passive bond funds are starting to see the bulk of inflows.