Jim Palmer, CFA, Chief Investment Officer

The Fed’s Got Your Back

It may be a minority opinion, but for a meeting with no indication of imminent rate cuts, the May 1 Federal Open Market Committee (Fed) meeting had a few we’ve got your back vibes.

We are not talking about the near-term direction of rates policy, especially after Fed Chairman Powell acknowledged inflation has shown “a lack of further progress” and gaining confidence to cut rates “will take longer than expected.” Those observations effectively take the June 12 and July 31 meetings off the table for rate cuts given how difficult it would be for the Fed to credibly claim progress on inflation with so few data points between now and then. Restrictive for longer is the Fed’s base case for now.

Hawkish Fed comments were necessary given the resilience of both the economy and inflation. But there were moments for investors seeking comfort. I appreciated the chairman’s comments, “I think it’s unlikely that the next policy move will be a hike” along with “I do think it’s clear that policy is restrictive” and “we believe, over time, it will be sufficiently restrictive.” These points help put a soft ceiling on yield curve levels by clarifying the direction of the next rate move. Further, the Chairman suggested with inflation below 3%, the Fed’s employment goal comes back into focus. Implying there is a second path to rate cuts via rising unemployment. A path which may not require declining inflation measures.

Additionally, the Fed announced it is reducing the pace of monthly balance sheet runoff by $35 billion. In Chairman Powell’s words, “It really is to ensure that the process of shrinking the balance sheet down to where we want to get it is a smooth one and doesn’t wind up in – with financial market turmoil the way it did the last – the last time we did this and the only other time we’ve done this.” Sounds good to me. It’s clear the Fed has no interest in creating a bank or financial market funding crunch.

Is it November Yet?

You may have heard it is an election year. And with it, we can expect a wide variety of ideas and policies to be floated by players of all political variations. According to the Wall Street Journal, Donald Trump allies are working on plans to weaken the Fed’s independence should the former President reclaim the Oval Office. For its part, the Trump campaign has not officially endorsed the concept. Just as well, because politically – not to mention economically - this plan makes little sense and has no chance being enacted. None. 

First, eroding the Fed’s independence implies a bias toward employment and economic growth and away from price stability. To me, it seems unlikely President Biden’s relatively low approval ratings on the economy are due to a 3.9% unemployment rate or record stock prices. The reason is obvious – inflation. Or more precisely, the 19.8% increase in the consumer price index since January 2021. Toss in historically low housing affordability measures, an inflation derivative, and many Americans feel disillusioned at the current state of the economy. Until recently, inflation was low and not on voter’s radar. It is now. And voters are looking for someone, anyone, to hold accountable at the ballot box. The point is no politician should assume voter priorities are constant.

Speaking of accountability, does any sitting president, regardless of party affiliation, really want to be held responsible for monetary policy? Having influence may sound good in theory, but my guess is presidents, and Congress for that matter, are more than happy to collect the political spoils of prosperity while having a powerful foil to publicly hold to account for economic pain. 

And finally, the White House and Congress already have considerable influence on monetary policy and the Fed’s regulatory framework via the nomination and confirmation process. Presidents have the opportunity to submit candidates with similar policy views to their own, and Congress has the power to reject those candidates. The Fed is staffed with capable individuals, so the process must be working. Would the process be as effective if the primary job of Fed Chair was to simply carry water for the White House. Probably not. And really, what top economist would want the job – much less be able to get confirmed - under those conditions?

USBAM Strategy

How does all this impact our strategy? In a nutshell, USBAM’s near-term outlook is 1) while we may be here for a while, the Fed appears to be at peak policy rates, 2) the Fed is biased to cut, not raise rates, 3) short-term yield curve levels are fair to attractive, and 4) the market is biased to push rates lower, implying the risk of a sharp move in yields is skewed toward lower rather than higher. Translating those assumptions into portfolio positioning involves tactically extending duration, or in non-bond market jargon, locking in current levels for the longer-term. 

Sources

Bloomberg

Restuccia, A., Timiraos, N., Learly, A. "Trump Allies Draw Up Plans to Blunt Fed's Independence," The Wall Street Journal. April 26, 2024.

https://www.brookings.edu/articles/how-voters-feel-about-the-economy-4-takeaways-from-the-latest-polls/

*Transcript of Chair Powell's Press Conference -- May 1, 2024 (federalreserve.gov)