2nd Quarter 2024 Review
• At the most recent FOMC meeting in June, Fed officials signaled that they expected just one 25 basis point cut in 2024; however, the Fed Funds Futures market is poised for two 25 basis point cuts this year
• Interestingly, the FOMC raised its long-term inflation expectations once again, but left growth and unemployment expectations unchanged for the rest of the year
• The core rate of inflation continues to moderate but is still higher than the Federal Reserve’s stated target of near 2%. The Federal Reserve’s preferred measure of inflation, the core PCE price index, was 2.60% year over year at the end of May
• U.S. Treasury (UST) yields rose during the quarter due to stronger-than-expected growth and stickier inflation
Below are select Bloomberg fixed income index returns for Q2 and Year-to-Date 2024:
Markets
A self-proclaimed “data-dependent” FOMC has all financial markets focused upon the most recent inflation, employment, and other economic data reported in order to extrapolate their respective impacts upon monetary policy in the months ahead. During the first quarter, a string of inflation data points headed in the wrong direction, causing interest rate futures to re-adjust from an overly optimistic bet on rate cuts at the end of 2023, to a range closer to the Fed’s own expectations as expressed in their December meeting. For most of the second quarter, that closer proximity was maintained, even as the Fed made significant adjustments to its “Dot Plot.”
The 2-year Treasury note posted a low yield for the first half of 2024 of 4.62% in March. The high yield of 5.04% occurred in April, while the 2-year note ended the quarter at 4.75%. The 2-year rate is considered, by most observers, to be a good harbinger of future Fed policy levels.
Meanwhile, the 10-year Treasury note achieved a low yield of 4.20% in March and a high yield of 4.70% in April. The 10-year UST ended the quarter with a yield of 4.40%.
Despite multi-year record new issuance and continued tightness in yield-spreads, both Corporate Investment Grade and Corporate High Yield turned in strong relative performance for the second quarter. Although dealing with a supply-related mid-quarter slump, high-grade municipal bonds ended the quarter at fairly rich price levels.
The Fed
The May FOMC meeting was relatively uneventful, the major news story being the official announcement of the start of the Qualified Tightening (QT) taper. The “taper” is the roll-off of maturing bonds purchased by the Fed in the open market during the pandemic in their effort to keep longer-term rates very low. In short, the Fed is not reinvesting the proceeds from maturing securities in order to shrink its balance sheet. The Fed announced it would allow up to $60 billion of Treasuries and $35 billion of Mortgage-Backed Securities (MBS) to “roll-off” monthly. The cap on Treasuries was reduced to $25 billion.
Fed Chairman Jerome Powell also reiterated it was likely that obtaining “greater confidence” (that inflation was trending sustainably towards 2%) would take longer than expected.
The second FOMC meeting in Q2 (which occurred in mid-June) brought with it a more significant update- the dots within the “Dot Plot” moved down. On average, FOMC members’ expectations for monetary policy for the remainder of 2024 entailed a single 25 basis point rate cut, instead of three as had been indicated at the end of 2023.
Of note, FOMC members also increased their long-run Fed Funds target rate estimate to 2.75%. This was the second upward adjustment in the estimate by members this year.
Presently, financial market participants (especially those in the overnight interest swaps market and the Fed Funds futures market) predict two 25 basis point rate cuts before the end of the year, with one likely taking place in September and another in December.
Moderation is Best in All Things
Inflation Data trended lower during Q2. Core CPI data for the month of April (released in mid-May) fell 0.2% from its level in the previous month. In June, both the May Core CPI data and the May Core PCE data fell further. The annualized rate of Core PCE Inflation now sits at 2.6%, a far cry from the 7.2% peak of mid-2022, and much closer to the Fed’s target of 2%.
The Fed continues to use 2% Core PCE inflation as its goal- but what will it take for them to achieve “greater confidence” that inflation is heading sustainably in that direction? Some surmise this means three consecutive Core PCE data points trending sequentially lower. If such is the case, there is a short window for “greater confidence” to be achieved prior to the September FOMC meeting. Essentially, both the June PCE data (released in late July) and July PCE data (released in late August) must indicate continued moderation. Several of the resources we follow expect the FOMC, in its July meeting, to “set-up” markets for a possible September cut.
Employment
To promote maximum employment and price stability are the U.S. Federal Reserve’s stated “dual mandate”. Until very recently, the primary focus has been fighting inflation as a means of promoting price stability- but it’s also important to watch employment.
Since early June, the U.S. Unemployment Rate has increased from 3.9% to 4.1%, with the latest data point released on July 5th. While this small increase is not enough to trigger the Sahm Rule (a leading recessionary indicator), it is more than just “something to keep an eye on.” Fed Chairman Powell has already admitted that if the unemployment rate should spike meaningfully upwards, it would likely result in the Fed adjusting expectations. Essentially, any material increase in the unemployment rate above 4% will add pressure on the FOMC to cut the Fed Funds rate.
The remaining employment data received during Q3 will become a critical component of the Fed’s decision-making process for their September FOMC meeting.
What We Think
Depending upon your source of information, the US economy is either heading for a soft landing or over a cliff. There’s not much conversation in between. By most measures, domestic inflation is significantly lower over the past year and recent inflation data continue to indicate a trending moderation. Chair Powell has stated publicly that the FOMC will consider its first cut before the 2% level is reached, if there is confidence among FOMC members the trend is sustainable.
Likewise, it also appears employment and wage growth, the two most robust indicators of continuing economic strength, are showing signs of recent moderation. As observed earlier this year, most of these indicators have proved to be relatively “bumpy,” with seasonal factors playing a large part in volatile readings. If these trends continue, it is highly likely the “wait and see” members of the FOMC will feel more comfortable easing monetary policy in the next few months.
Numerous global and domestic conditions in place before, and continuing after the pandemic, will likely imbed some structural inflationary pressures in certain sectors of the US economy. Highlighted in our recent quarterly pieces and indicative of these circumstances, the individual members of the FOMC have started to slowly increase the level of the long-range Fed Funds target rate. We will continue to monitor this development closely as it bears directly on where the Fed’s overnight rate will ultimately level off.
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.
