The first much awaited FOMC meeting of the year happened yesterday and brought some clarification to investors regarding the Fed’s stance on rates. While Chairman Powell was quite satisfied with the work done to reign in inflationary pressures, he clearly stated that a rate cut in March is very unlikely and that he needs more data (not necessarily better) to solidify the Fed’s opinion that inflation is indeed receding for good.
Powell also indicated that now there are three projected rate cuts for 2024. The timing of these cuts is tricky as the need for more data pushes them forward. However, in November we will need to deal with a presidential election, an event around which the Fed prefers to stay pat. Depending on how macro data comes in, perhaps we see two cuts in spring/summer and one after the election.
Ultimately, the Fed is under no pressure to cut too fast as the labor market remains tight. However, we do see little cracks in the goldilocks scenario as regional banks seems to be under some stress (again….) due to overexposure to commercial real estate loans. Furthermore, earnings from some of the tech titans were fine but certainly not extraordinary while valuations are just about one standard deviation above long-term averages. In the valuation front, growth is expensive while value is relatively cheap. Growth tends to consistently outperform in a low-rate environment but in a normalized rate environment, value can do much better.
In this environment, bonds continue to look attractive as providers of positive real yield and negative correlation to equity risk.
In fixed income, inflation protected securities also remain in favor as a hedge against inflation receding more slowly than anticipated. Emerging market bonds denominated in local currency are back in favor given the yield advantage and a possible tailwind from currency appreciation.
And now the wait starts for the next Fed’s meeting……..