For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
For the final quarter of last year, markets were pricing in an increasingly dovish outlook for Fed Funds (see chart below). However, since the turn of the year, markets have been pricing in a more hawkish environment, or a higher for longer environment (in the chart we have used the amount of rate cuts that markets expect in Fed Funds by the end of the year, as a proxy for the Fed Funds outlook).
The graph also shows that the outlook for Fed Funds continues to be a key driver for bond and currency markets. For example, the more hawkish outlook this year has led to a stronger US dollar and a higher US Treasury yield, the reverse of the dynamics at the end of last year.
The outlook for Fed Funds and what it has meant for US currency and Treasury markets.
Source: Bloomberg Finance L.P – 04/10/2023 – 01/05/2024
Inflation has been hotter than the market expected this year and, logically, higher expectations for Fed Fund rates have supported higher US Treasury yields and a stronger US dollar. Indeed, the US Treasury 10 year yield hit a five month high last week.
Our clients are very aware that we have had a higher for longer inflation environment as our base case for almost two years now. We continue to see elevated inflation risk, and this has a major impact on how assets behave in relation to each other, which is of upmost importance when running multi asset. For example, we wouldn’t expect bonds to help diversify equity risk when inflation risk is front of mind.
Equities, meanwhile, have been dancing to their own beat, yes they benefited in the last quarter when rate expectations were more dovish but, even in the more hawkish months of this year, they have been moving higher, regardless of higher US treasury yields and a stronger US dollar. Strong US growth fundamentals, at a macroeconomic and corporate level, have provided some support to risk assets, though there has been an attempted pullback in equity more recently.
The outlook for Fed funds continues to drive markets, as it has done for decades. The difference over more recent times is that it is a concern around (hot) inflation, not (weak) growth that is the underlying dynamic. Markets are now only pricing in one cut this year, versus six cuts at the beginning of the year. Is it a hike, rather than a cut next in play?
It’s not our approach to be so precise with our expectations. In part, it’s because such precision will rarely be right but even if it is, how much more helpful is it than getting the trend right? As such, we remain with our higher for longer trend base case. For portfolios this means short duration in bonds, providing attractive income but with minimal expectations for diversifying equity. Elsewhere we remain materially exposed to real assets, for example equity, commodities and some property.
Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
