Week of February 13, 2023
On February 23, our investment professionals across SLC Management, BGO , InfraRed Capital Partners Ltd and Crescent Capital Group LP provide invaluable insights into what lies ahead for traditional and alternative investments, as well as for the global economy. Panel discussion followed by Q&A. Register for our country-specific sessions by clicking the links below:
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
American consumers continue to ignore any threats of a slowdown. January’s retail sales rose by 3%, the best showing in over two years (when vaccines were first rolled out). Every retail category showed monthly and year-over-year increases. Vehicle purchases surged. All this comes on the heels of a stellar jobs report a few weeks ago and an inflation reading this week that showed some cooling, but less cooling than expected. And with wage growth strong the economy is still in high gear.
As these vibrant data fill up the U.S. Federal Reserve’s dashboard, it looks likely the central bank will need to push rates higher than initially expected. At the beginning of the month, the Fed Funds futures market expected the Fed to pause its rate hikes somewhere below 5.0% but now expects to be above that.?
While we should certainly be grateful for a robust economy, it does suggest the Fed may be forced to keep rates higher for longer.
Source: U.S. Department of Commerce, 2023.
Annette Serrao, CFA , Managing Director and Portfolio Manager, Long Credit and LDI
Persistently high inflation, a strong job market and strong retail data indicate that the Fed's rate hikes have not been able to achieve the central bank’s intended goal yet. The macroeconomic numbers coming out every month still hint that the Fed's hiking cycle is probably far from the finish line.
For pension plans, strong equity returns so far in 2023 have somewhat offset the impact of moves in interest rates. The average funded status of pension plans remains above 100%. In our view, contraction in corporate earnings, margin compressions and the probability of a recession are not fully reflected in recent equity market performance. Given the recent bounceback in bond yields, institutional investors may need to take another look at this renewed opportunity to de-risk and lock in the funding status of overfunded pension plans.
Source: Milliman, 2023.?
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Trevor Forbes CFA MFin , Managing Director, Public Fixed Income – Total Returns Portfolio
Canada 10-year yields have moved notably higher in February, reversing all the fixed income gains from January. The fixed income market is finally capitulating to the Bank of Canada, with rates being higher for longer as the expectation for future rate cuts this year has now been reversed to a potential 25-basis-point (bp) hike in Canada. While the Canadian yield curve remains significantly inverted, the timeline for the BoC to normalize rates is getting pushed further out into the future as significantly strong employment numbers on both sides of the border raise the specter of sticky service inflation, which could make hitting 2% inflation as per the consumer price index a longer-term goal. For plan sponsors who felt they missed the first opportunity to lock in at the rate levels seen earlier this year, it seems the markets have granted them a second chance.
Source: Bloomberg, 2023.
John Bichajian III, CFA , Senior Director, Derivatives & Quantitative Strategy
About a month ago, we flagged that the Fed Funds futures market was implying a peak rate of 4.9% in June, coupled with approximately 50 bps of cuts in the back half of the year, leaving the federal funds rate under 4.4% by December. At the time, the Fed’s board members’ and presidents’ median year end projection was 5.1%, which created a significant 70-bp chasm between market expectations and the board’s forecast.
After the February Federal Open Market Committee (FOMC) rate decision and the blowout non-farm payroll numbers, Federal Reserve Bank of San Francisco President Mary Daly said that central bank officials’ December projections for interest rates were still a good signal of where borrowing costs are headed for the end of the year.
While the FOMC’s forecast of 5.1% has barely budged according to Daly, market expectations implied by Fed Fund futures have increased at a rapid clip since mid-January, converging at the same 5.1% level. Typically, sharp increases in market rate expectations have been associated with significant weakness in equities and credit, but this time we have seen risk assets skyrocket instead. Market participants should be on high alert for signs that the typical negative correlation between risk assets and rate expectations is starting to reassert itself, as “this time may be different” can be a dangerous phrase.
Source: U.S. Federal Reserve, 2023.
Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.
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