As we concluded the first half of 2024, the economy as measured by GDP was strong, but slowing. The third revision of annualized GDP for Q1 was 1.4%[i] which may allow the Federal Reserve to cut by year end, probably after the election. This is a far different outlook than the beginning of the year, where market expectations predicted through Fed Fund Futures[ii] that the Fed might embark on six rate cuts by year end. The Federal Reserve Summary of Economic Projections in June indicated that members of the FOMC predicted just one “25 basis point” cut in 2024[iii].
A key measure of inflation, the Consumer Price Index year-over-year change was 3.3% in May, down from 3.5% in March[iv]. This remains stubbornly high, however it is trending down, and combined with a PCE release of 2.6%[v] may give the Federal Reserve an opportunity to lower rates. We have conviction that the Federal Reserve will want to lower rates as more economic data trends towards disinflation. A rate cut of 25 basis points does not mean rates will come down quickly, as higher rates are forecast for several years based upon the Federal Reserve forecast released in June[vi].
The June unemployment rate of 4.0%[vii] is trending higher, however is technically considered full employment by all historical standards. The chart below represents a temperate unemployment rate but rising as a result of restrictive monetary policy. Chairman Powell noted in recent congressional testimony that if inflation data is trending in the desired direction, then the Federal Reserve may start to lower rates, before it enters the desired target range. The Fed is using monetary policy to slow the economy down but will try to minimize undue hardship in the labor markets. The rise in the unemployment rate is definitely something that is not going unnoticed.
Source: Bureau of Labor Statistics as of 6/30/2024
The yield curve remains inverted. The 2-year/10-year Treasury yield spread has been inverted since July 2022 and indicates that investors expect lower interest rates at some point in the future. This current inversion is the longest in decades (1978) and may stay inverted until rate cuts are enacted.
Source: Bloomberg as of 6/28/2024
We will position our strategies to take advantage of the inverted yield curve by positioning our holdings to the curve using a barbell strategy as opposed to a ladder. This will allow us to take full advantage of the points on the curve that provide the highest yields.
The economy is showing some signs of slowing, however it is still resolute to historical averages. We will continue to favor corporate issuance as corporate balance sheets remain robust. Corporate spreads in most sectors are at multi-year lows, which is indicative of the strong economy.
As we enter the beginning of a possible rate cutting cycle, we have been increasing portfolio duration in all strategies to neutral.
SWS Capital Management’s (SWSCM) philosophy is based on a value-oriented, active management style which emphasizes liquidity and risk management. This philosophy is woven into all our strategies. Security selection, sector allocation, and yield curve positioning are based upon our interest rate forecast as well as our fundamental economic outlook.
As always, we appreciate your business.
Source: Bloomberg as of 6/28/2024
Disclosure
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance. Investing involves risk including loss of principal. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.
[i] GDP US Chained Dollars QoQ SAAR – Bureau of Economic Analysis – Third Revision
[ii] Fed Funds Futures - Interest Rate Probability as of 1/31/2024
[iii] Summary of Economic Projections – Federal Reserve Board 6/12/2024
[iv] US CPI Urban Consumers YoY NSA – Bureau of Labor Statistics
[v] US Personal Consumption Expenditures Chain Type Price Index YoY SA – Bureau of Economic Analysis
[vi] Summary of Economic Projections – Federal Reserve Board 6/12/2024
[vii] U-3 US Unemployment Rate Total in Labor Force Seasonally Adjusted – Bureau of Labor Statistics
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