By Bill Smith, Fixed Income Trader and Portfolio Manager
On Sept. 18, the Federal Open Market Committee (FOMC) cut interest rates by 50 basis points (bps), commencing its first easing cycle in nearly four years with a bang. Most analysts expected 25 bps, as “jumbo” cuts are generally reserved for periods of clear economic stress. To this point, Federal Reserve Governor Michelle Bowman became the first FOMC member to dissent since 2005, arguing that 25 bps would have been more appropriate given the strength of the U.S. economy and that inflation remains above the Fed’s 2% target. For his part, Fed Chair Jerome Powell rationalized the larger move in his post-meeting press conference, explaining the committee’s growing confidence that inflation is moving sustainably towards 2%. The 2.2% year-over-year read on the personal consumption expenditures price index (PCE) last Friday, the Fed’s preferred measure of inflation, certainly lent some credence to this argument. Powell also noted that while the labor market is cooling, it is still strong and that “our intention with our policy move today is to keep it there.” He explained that the “time to support the labor market is when it’s strong and not when we begin to see the layoffs.”
Given this rationale, the FOMC appears firmly committed to future policy easing. According to the Fed’s updated summary of economic projections, an additional 50 bps of cuts are expected in 2024 and 100 bps in 2025. The Federal Funds futures market is slightly more aggressive, calling for 75 bps this year and between 100 and 125 bps next. Regardless of the exact path, the destination appears clear – baring a significant surprise in inflation or employment data, rates will likely be lower moving forward.
The charts below summarize the yield and performance of select fixed income indices and tenors as of September 2024.
Past performance is no guarantee of future results.
Fixed income generally performs well when the Federal Reserve cuts interest rates. Looking at the previous ten easing cycles since 1989, buying bonds at the beginning of a cycle (first cut) has largely resulted in positive one-year total returns across fixed income asset classes. For instance, the Bloomberg U.S. Aggregate index has an average one-year total return of 6.15% during these periods, and was positive nine times out of ten, as shown in the chart below.
Source: ICE BofA Indexes, Bloomberg. Past performance is no guarantee of future results.
Broadening the scope to include all fifty-seven rate cuts since June 1989, the return potential during easing cycles appears even more compelling. The Bloomberg U.S. Aggregate index, for example, has averaged a 7.65% one-year total return after each cut and was positive 94% of the time (53/57). Since this trend is largely seen across fixed income asset classes, it would suggest that on average, the trajectory of interest rates may be more important than perfect timing.
Source: ICE BofA Indexes, Bloomberg. Past performance is no guarantee of future results.
It is also important to note that cash and short-term money market instruments generally underperform in falling rate environments, as demonstrated by the Bloomberg Short Treasury Index in the tables above. Short-end investments have higher reinvestment risk, and their yields usually track the Federal Funds rate closely. The yield on a three-month Treasury Bill, for instance, has fallen 66 bps in the last 60 trading days (5.09% to 4.43% as of 9/30) and now sits roughly 32 bps below the lower bound of the current Federal Funds target range (4.75 – 5.00).
For investors contemplating an allocation to fixed income, especially those who are overweight cash, missing the first cut doesn’t necessarily mean missing the opportunity. Yields are still attractive, and fixed income has historically performed well across easing cycles.
A prudent approach to fixed income investing calls for diversification across both credit and duration exposure.
As always, we recommend staying balanced, diversified, and invested. Despite short-term market pullbacks, it’s more important than ever to focus on the long-term, improving the chances for investors to reach their goals.
Important Disclosures
This commentary is provided for informational and educational purposes only. The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. This is not intended to be used as a general guide to investing, or as a source of any specific recommendation, and it makes no implied or expressed recommendations concerning the manner in which clients’ accounts should or would be handled, as appropriate strategies depend on the client’s specific objectives. This commentary is not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Investors should not assume that investments in any security, asset class, sector, market, or strategy discussed herein will be profitable and no representations are made that clients will be able to achieve a certain level of performance or avoid loss. All investments carry a certain risk and there is no assurance that an investment will provide positive performance over any period of time. Information obtained from third party resources are believed to be reliable but not guaranteed as to its accuracy or reliability. These materials do not purport to contain all the relevant information that investors may wish to consider in making investment decisions and is not intended to be a substitute for exercising independent judgment. Any statements regarding future events constitute only subjective views or beliefs, are not guarantees or projections of performance, should not be relied on, are subject to change due to a variety of factors, including fluctuating market conditions, and involve inherent risks and uncertainties, both general and specific, many of which cannot be predicted or quantified and are beyond our control. Future results could differ materially and no assurance is given that these statements or assumptions are now or will prove to be accurate or complete in any way. Past performance is not a guarantee or a reliable indicator of future results. Investing in the markets is subject to certain risks including market, interest rate, issuer, credit and inflation risk; investments may be worth more or less than the original cost when redeemed. For additional information, please refer to FD Wealth’s Form ADV Part 2A Brochure publicly available on the SEC’s website (www.adviserinfo.sec.gov) or by contacting us at info@fdwealth.net.