December 2, 2022
Is the Fed finally Relenting? In a speech at the Brookings Institute, Chairman Powell laid out the Central Banks’ current thinking on the economy, rates and the path forward. In the speech, littered with caveats, the Chairman said what the market expected, and needed. The Fed is thinking of relenting. After 4 record 75 basis point increases to the Overnight Fed Funds rate, a UK Pension-Gilt crisis and the decline of risk assets (Some spectacularly), the Fed is thinking of only raising rates 50 basis points at its December 14th meeting. Did we ever think the markets would be happy for a ½ a percentage point increase in interest rates?
But markets are notoriously short sighted and in celebrating the potential peak of inflation and the light at the end of this interest rate cycle, they are missing a clear sign of the next challenge. On November 8th, something happened that rarely happens, and it has historically been a solid signal of a recession to come, the yield on the 3-month Treasury surpassed the yield on the 10-year Treasury. Also know as an inverted yield curve, right now, you get more yield for lending your money to the government for a shorter time, than you do for a longer time. This counter intuitive situation happens when the markets expect inflation to subside, but short-term rates are still high. Why would inflation subside? Because we are going to have a recession and when we have a recession, demand dries up, jobs are lost, wages stagnate, and prices fall.
What makes this inversion unique is the continuation of Fed rate hikes. Looking back, if the curve inverts, it’s after a rate cycle ends, not before. This Fed, hyper focused on not repeating the mistakes of the 70’s, has stated their intention to raise rates higher and hold the terminal rate for longer. This potentially increases the depth and duration of the recession.
All this adds up to, it’s a great time to be in bonds. While we remain cautious extending into credit, we see opportunities in fixed income without having to take credit risk. Short US Treasury issues have attractive yields and are an excellent place to ride out the coming volatility. We also see good value in longer high-quality tax-free municipals and high grade, liquid corporates where yields are attractive and rates should be stable.
We are using this respite in the markets as a great time to prepare for the coming storms. Repositioning portfolios out of lower quality and less liquid assets, into higher rated, highly liquid assets. This should pay off as the recession clouds gather and liquidity dries up.
-Peter Baden, CFA
Chief Investment Officer
Click on the above links for more information on important investment and economic concepts.
Yield Curve Inversion
Generic 10 Year Yield less the Generic 3 Month Yield
Yield Curve Inversion
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William (Kip) Weese
SVP, Intermediary Sales
Northeast & South West
VP, Intermediary Sales
VP, Intermediary Sales
North Central & North West
Indexes used for AAA Municipal Yields
2 Year: BVAL Municipal AAA Yield Curve (Callable) 2 Year (Symbol: CAAA02YR BVLI)
5 Year: BVAL Municipal AAA Yield Curve (Callable) 5 Year (Symbol: CAAA04YR BVLI)
10 Year: BVAL Municipal AAA Yield Curve (Callable) 10 Year (Symbol: CAAA10YR BVLI)
30 Year: BVAL Municipal AAA Yield Curve (Callable) 30 Year (Symbol: CAAA30YR BVLI)
Indexes used for US Treasury Yields
2 Year: US Generic Govt 2 Year Yield (Symbol: USGG2YR)
5 Year: US Generic Govt 5 Year Yield (Symbol: USGG5YR)
10 Year: US Generic Govt 10 Year Yield (Symbol: USGG10YR)
30 Year: US Generic Govt 30 Year Yield (Symbol: USGG30YR)
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