Investment Insights: When hawks cry

Wade Balliet
Posted by Wade Balliet
Investment Strategy

Fed BuildingThis weekly report presents insights from our Global Investment Management team.

As Jerome Powell heads to Capitol Hill for a two-day report out, it’s more tense than usual for the Fed Chairman as he faces an onslaught of quips from Congress.

The strong jobs report has some scratching their heads, as if they almost wanted it to be weak so as to justify an aggressive cutting of the fed funds rate. Instead, the jobs report came in strong and the market took the news as if they were children expecting two scoops of ice cream, but now may only receive one – let the whining ensue. We have written previously about how the delicate balance between too hot or too cold creates a bit of a paradox: strength in the economy may be met with “sells” because it means that a 50 basis points cut is more than likely off the table at the next meeting.

With that said, Bloomberg currently reports a 100% probability of a rate cut at the July Fed meeting. Ultimately, it will be hard to hold out against “not doing anything” given the current rhetoric surrounding the Fed and the fact that the United States actually has some room to cut. Looking at central banks across the globe, the Fed is one of the few that has some capacity to reduce interest rates without going into – or deeper into – negative territory. Currently, if the Fed were to cut by 25 basis points at each meeting, this would mean that we could get through nine meetings before reaching zero. A fairly unlikely scenario. The Fed’s ability to point to the strong jobs report and a continuing expansion, despite some transitory slowing and a separation in inflation, should be enough to solidify the current wait-and-see approach.

As is the case with these testimonies, markets anxiously await the prepared remarks as well as the multiple hours of questions and answers that are used to glean some sense of the next policy move. Regardless of the exact timing, if the long end of the curve remains relatively stable and we do in fact see two rate cuts by the end of the year, this might be enough to reverse the inversion in the yield curve. Even if they slow down the process, we believe the Fed will likely continue to offer enough transparency to telegraph its intentions in order to limit volatility in the financial markets and forestall the guessing game regarding monetary policy. There should really be no surprises here.

We continue to advocate for a small overweight to equities, as these securities currently have the best opportunity to outperform inflation and make real returns possible. Fixed income remains underweight in our strategies as value has eroded due to decreasing interest rates and high valuations. Despite this, we have allocated more to the fixed income asset class as we have taken profits and purchased shorter-term high quality bonds to protect portfolios against volatility, which we expect to increase in the coming months given the headwinds that investors will face. For now, we continue to believe that a slight overweight to equities and a cautious stance within the sub-macro asset classes of both equities and bonds is the best way to manage return objectives while keeping risk in check.

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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