“ The effective impact of more money means consumption will go up and prices will go up meaningfully ,” he says .
More market participants think the Fed ’ s 2 % target for inflation could prove elusive , and that the measure will swing around 3.5 % or 4 %. “ The Fed is going to [ have to ] decide how quickly they want to get to 2 % in an election year in 2024 ,” says Permanent Portfolio CEO Michael Cuggino . Like Fuss , he is dubious that target will be met .
Brad McMillan , chief investment officer of Commonwealth Financial Network , delivered a similar message to advisors at the firm ’ s annual conference this year in Denver . Over the last 70 years , interest rates have mostly fluctuated between 4 % and 8 %; the two exceptional periods were the 10 years from 1975 to 1985 and the pre-Covid decade . McMillan says that when he mentions the possible 8 % upper limit it jolts people anesthetized by the rates of the previous decade .
But as both the 10-year and 30-year interest rates danced around 5.0 % in mid-October , there ’ s now real concern about future interest rates and the bond market ’ s capacity to consume a surge of new bond issues from the U . S . Treasury . With the economy running at full employment , the federal budget deficit of $ 1.6 trillion is now about 8 % of GDP , requiring the Treasury to sell about $ 130 billion of bonds a month . The deficit was only 2.6 % of GDP in 2016 , but rose to 4.8 % in 2019 — and then soared during the pandemic .
The CEO of DoubleLine , Jeffrey Gundlach , has described the bear market in bonds as a “ 40-year regime change .” At a company event in October , he voiced amazement that no one was talking about the interest expense problem for the federal government . Before the pandemic , he worried the budget deficit could reach $ 2 trillion in the next recession . Now it ’ s within striking distance of that figure while unemployment nears a 50-year low .
At the same time , this has given investors more reason to be attracted to bonds . All you have to do is look at what it took to earn a 5 % yield in late 2021 .
The bullish case for fixed income today , argued by many like the strategists at bond giant Pimco , rests on the assumption that both growth and inflation have peaked .
At that time , investors “ needed to buy a junk bond and leverage it 50 %,” Gundlach said . Today , one can buy short-term Treasury bills and get 5 %.
So after a brutal 2022 , 2023 was supposed to be kinder to bond investors than the first 10 months turned out . But the bullish case for fixed income today , argued by many like the strategists at bond giant Pimco , rests on the assumption that both growth and inflation have peaked .
Meanwhile , most of the leading economic indicators have been flashing recession signals for the better part of two years , prompting some , like MFS Investment Management ’ s chief economist and portfolio manager Erik Weisman , to conclude that either the economy has fundamentally changed or monetary policy lags have been elongated by the pandemic and unprecedented stimulus . Larry Summers , the former U . S . Treasury secretary , was among the first to see that inflation was going to stick around , though he and others have been wildly wrong about employment . He ’ s now questioning whether monetary policy still works .
Not everyone is buying into the “ higher rates for longer ” narrative . “ We see greater recession risk than the markets are pricing in ,” said Pimco executive vice president Nicola Mai , managing director Tiffany Wilding and global fixed-income chief investment officer Andrew Balls in an October 11 outlook paper . By the end of 2024 , they see inflation in the U . S . and Europe running from 2.5 % to 3.0 %.
They worry about a big rupture . “ History suggests that tight financial conditions create a high risk of financial accidents and there are areas of vulnerability within markets , such as private credit , commercial real estate and bank loans ,” they wrote .
Some still think there ’ s a hard landing around the corner — a likely plunge into recession . But that much anticipated scenario keeps being eclipsed by higher consumer confidence and employment , which continue to defy expectations . In fact , two of the biggest economic problems are the struggle of companies to find workers and getting home buyers to buy homes .
Increasingly , the business cycle appears to be driven by consumer spending rather than manufacturing , Commonwealth ’ s McMillan notes . Consumer confidence remains high in the short term , though he notes that Americans are worried about the longer term .
The economy continues to hum , in part it seems because of the massive increase in wealth that began after the Great Recession and continued through the pandemic . A recent Federal Reserve survey found that Americans ’ net worth climbed 37 % between 2019 and 2022 on the heels of a decade-long bull market in stocks . There is now a huge cohort of baby boomer retirees living it up in the so-called “ go-go ” years of early retirement .
If Europe and China march into recession in the next 18 months , the U . S . isn ’ t certain to follow them . Unlike it was in the previous decade , the Fed is now in a position where it has plenty of room to cut interest rates . Moreover , with unemployment under 4.0 %, job security ranks near the bottom of most people ’ s concerns .
NOVEMBER 2023 | FINANCIAL ADVISOR MAGAZINE | 17