Evan Simonoff
Evan Simonoff
THE BIG PICTURE
ing at mortgage rates . “ Yield is destiny ,” Tipp says .
Suddenly , equities face at least a hint of competition . According to the Investment Company Institute , $ 6.47 trillion sat in money market funds as of October 10 . Tipp expects a lot of that money to move into fixed-income securities .
Falling interest rates are almost always good news for bonds , but they are usually associated with a moderating economy .
While it ’ s not yet clear whether the U . S . economy is actually slowing or normalizing , it is clear that the impact of the huge fiscal and monetary pandemic stimulus is finally fading . It ’ s too early to anoint Fed chair Jerome Powell as a maestro — the moniker given to ex-chair Alan Greenspan after he engineered a soft landing in the mid-1990s . Powell was painfully slow to realize that the latest bout of inflation wasn ’ t transitory . But the central bank has managed to raise rates faster than any Fed leader since Paul Volcker while avoiding a recession . And for now , inflation appears neutralized .
consumer demand normalizes and competition for “ limited job openings ” increases , the Pimco executives wrote . Even in the U . S ., labor markets suddenly appear looser than they were in 2019 before the pandemic destabilized employment conditions . This has been underscored by the 1 % uptick in the unemployment rate in the last year .
One major surprise from the monetary tightening cycle that began in early 2022 is
“ Higher rates don ’ t necessarily cause a recession , but they hurt . This is an economy driven by job growth , not interest rates .”
Robert Tipp
Chief Investment Strategist and Head of Global Bonds at PGIM Fixed Income
that central banks have managed to raise rates aggressively without triggering a recession . That ’ s partly because of the massive stimulus policies of the pandemic .
But it also demonstrates the increasing impotency of monetary policy . Like an antibiotic that gets overprescribed , it appears to have lost some of its efficacy . Another factor limiting the effectiveness of monetary policy is existing homeownership . Despite the pain of higher rates , many people aren ’ t affected : An estimated 38 % of Americans own their homes mortgage-free , while millions of others were already locked in low-rate mortgages before interest rates rose .
“ Higher rates don ’ t necessarily cause a recession , but they hurt ,” Tipp says . “ This is an economy driven by job growth , not interest rates .”
A recession isn ’ t off the table , but most senior fixed-income investors like Tipp , Wilding and Balls see a soft landing as a more likely scenario . Tipp expects central banks to play it cautious and try to extend the expansion . “ Things are likely to get better than worse ,” he says .
Meanwhile , there is a growing consensus that as the Fed and other central banks lower rates the yield curve will steepen . This typically creates a favorable environment for fixed-income investments , Wilding and Balls maintain .
Bond market professionals would appear to be living in a near-perfect world after the bear market of 2022 . But there ’ s one problem : The market itself is already pricing in expectations of a favorable environment , leaving many fixed-income securities vulnerable to short-term setbacks , like the strong unemployment report in early October . As expectations change , volatility rises . And the monthly data in both inflation and unemployment is erratic at a time when many of the strong returns have already been earned from coupons this year . That ’ s why the capital appreciation of bonds has bounced around in 2024 .
It also explains why Tipp expects bond prices and yields to be range-bound for the next 12 to 18 months . The Fed itself has changed its estimate for the fed funds rate . Recently it was 4.2 %. Earlier , when the economy was looking weaker , it was 3.4 %. “ Our best estimate is 3.4 %,” Tipp says .
One contrarian who thinks the economy is already in a recession is Jeffrey Gundlach , the CEO of DoubleLine . Speaking on a webcast in early September , he said that by September 2025 economists would realize the economy had been in a recession for at least 12 months .
Like many others , Gundlach believes the Fed waited too long to cut interest rates and now thinks the central bank should cut the fed funds rate eight times , or by about 2 percentage points , and that the cuts should come sooner rather than later . Tipp estimates that there will be six cuts by the Fed , which has 10 meetings between now and the end of 2025 .
Many fixed-income experts think inflation has been subdued for the foreseeable future , but Dan Fuss , the vice chairman of Loomis Sayles , has his doubts . He thinks the potential for either higher tariffs or taxes in the next administration could spur businesses to raise prices . Furthermore ,
Inflation Normalizing
In an October 9 note to clients , Pimco ’ s managing director Tiffany Wilding and global fixed-income CIO Andrew Balls wrote , “ The factors that supported relative U . S . economic strength are diminishing . That suggests some recoupling with the rest of the world and further progress on curbing inflation .”
In much of the developed world , inflation appears to be returning to targets , as Continued on page 57
16 | FINANCIAL ADVISOR MAGAZINE | NOVEMBER 2024 WWW . FA-MAG . COM