1st Quarter 2024 Review
• U.S. Treasury (UST) yields rose during the first quarter due to stronger than expected growth and stickier inflation
• At the FOMC’s March meeting, Fed officials signaled that they expected three 25 basis point cuts in 2024, in line with adjusted market assumptions made since the beginning of the year
• Interestingly, the FOMC Statement of Economic Projections (SEP) modestly raised the outlook for growth and inflation and lowered unemployment expectations for the rest of 2024
• The core rate of inflation has declined but is still higher than the Federal Reserve’s stated target of near 2%, with the core PCE price index (the Federal Reserve’s preferred measure of inflation) at 2.80% year over year at the end of February
• Recent statements from several FOMC members, including Chairman Jerome Powell, seemingly support the gradual easing of policy restrictions but continue to push out the timing of the first actual rate cut
• We continue to recommend a cautious approach in core fixed income portfolios, avoiding longer duration and embracing higher quality in general
• Although watching economic trends closely, opportunities still lie in several more “peripheral” sectors of fixed income, including selected actively managed high-yield and asset-backed securities managers
Below are select Bloomberg fixed income index returns for Q1 2024:
A mere hint at the peak of the current monetary policy cycle back in November 2023 sparked an overzealous Treasury rally, during which market expectations swelled to six or seven rate cuts in 2024, well ahead of the Fed’s own projections. In contrast, the inaugural weeks of Q1 marked a significant pullback in this U.S. Treasury rate rally, largely due to an unanticipated spike in inflation.
The 2-year Treasury note sported a low yield of 4.14% in January, with a high yield of 4.73% notched in March before the FOMC meeting. The 2-year UST yield ended the quarter at 4.62%. Meanwhile, the 10-year Treasury note saw a low yield of 3.88% in January and a high yield of 4.32% in March. The benchmark Treasury yield ended the quarter at 4.20%. With volatile UST yields rising, most high-quality fixed income sectors suffered negative returns for the first quarter.
Investment grade new issuance was at record levels during Q1, with high-yield new issue activity reaching multiyear highs. Although credit spreads (the differential between the market yields of various fixed income sectors compared to U.S. Treasury notes or bonds of similar maturities) remain at or near historically “tight” levels, the more substantial cash flows available in lower quality names led to robust demand and a material outperformance versus higher-quality corporate credits, Treasuries, and municipal bonds.
Below is a graph of the changes in UST yields during Q1 2024:
The green line is the UST yield curve as of 3/28/24 and the yellow line is the UST yield curve as of 12/29/23. The lower panel bar chart represents the change in yields by various maturities for this time period.
The Fed
Overall trends remain favorable, but Q1 delivered a dose of continued healthy labor market numbers and sticky inflation. The first FOMC meeting of the year produced a few amendments to the Fed’s policy statement, including the removal of their bias towards further tightening. More importantly, however, was the statement, “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards two percent”.
The second meeting, which concluded on March 20th, generated additional surprises. Although the “Dot Plot” indicated the median expectations of FOMC members still shows three Fed Funds rate cuts in 2024, consistent with previous statements, there were notable increases in expected GDP growth (revised up from 1.4% to 2.1% for 2024) and PCE inflation (revised up from 2.4% to 2.6% for 2024). Additionally, there were fewer members supporting the median three cuts in 2024 (several projecting two or fewer) and the longer-range target rate projections for 2025 and 2026 were nudged slightly higher as well. In his press conference following the March meeting, Chair Powell said, “the economy is strong, the labor market is strong, so this gives us the ability to sit back and watch”.
What We Think
Reading formal statements from the Fed and listening to various FOMC members speaking publicly, it’s clear most members support cutting interest rates at some point in the not-too-distant future. Unfortunately, inflation and other economic data have not been strongly supportive of immediate cuts without some sort of rapid deterioration either there or in the labor market. Combine that with recent bumps-up in the longer-range inflation expectations from Fed members themselves and we believe a higher than currently forecast terminal rate is not an unreasonable possibility. McVean Chief Economist Michael Drury recently wrote, “the reality is that the U.S. economy continues to perform well without help from the Federal Reserve”.
With this scenario in the backs of our minds, we remain cautious about adding substantially to duration risk as many continue to espouse. Treasury markets (and other markets in following) have already adjusted for a fair number of future rate cuts, and generous short-term yields continue to appeal to us as numerous parts of the economy exhibit solid or acceptable levels of growth. We prefer to opportunistically embrace “risk” on the periphery with experienced high-yield and asset-backed securities managers; and stick to high-quality, more liquid names for our core fixed income allocations.
We hope you will contact either your Portfolio Manager or any member of our fixed-income team with questions regarding our outlook or these comments in general.
For additional information, please contact one of the commentary contributors below:
Sam Boldrick: sboldrick@argenttrust.com
Hutch Bryan: hbryan@argenttrust.com
Matthew Kimbrough: mkimbrough@argenttrust.com
Not Investment Advice or an Offer | This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing.
