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What’s next? Fed enters rate hike endgame
Ritchie Tuazon
Fixed Income Portfolio Manager
Tim Ng
Fixed Income Portfolio Manager
Tom Hollenberg
Fixed Income Portfolio Manager

The U.S. Federal Reserve raised its benchmark interest rate by 25 basis points (bps) this week, as inflation remains above target even as economic growth slows. 


The latest rate increase brings the federal funds rate to a range of 5% to 5.25%. Market pricing indicates this could be the final or penultimate hike this cycle, as the effects of monetary policy are becoming apparent (as highlighted most recently by the takeover of First Republic Bank). 


Fed Chair Jerome Powell suggested the current level of rates may be sufficiently restrictive to bring down inflation. He highlighted that the central bank made a “meaningful change” to its policy statement, removing language that signaled more rate increases would be appropriate.


“I think that policy is tight,” Powell said. “If you put the credit tightening on top of [the current level of rates] and the [quantitative tightening] that's ongoing, we may not be far off.”


However, he reiterated that no decision to pause had yet been made and pushed back against a suggestion that the Fed would cut rates by the end of the year.


Here are the latest views of fixed income portfolio managers Ritchie Tuazon, Tim Ng and Tom Hollenberg. They are members of Capital Group’s U.S. interest rates team.  

 
  • U.S. economic growth has broadly remained resilient while inflation has stayed at elevated levels, despite one of the most aggressive hiking cycles in decades.
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  • With policy rates climbing 500 bps in just over a year, the effects of monetary policy are starting to bite. The recent bank failures reflect, in part, the impact of much higher interest rates. Lending standards, which were already growing more restrictive prior to the collapse of Silicon Valley Bank, are likely to become more stringent. As a result, financial conditions are likely to continue tightening, and recession risk has increased.
  •  
  • While headline and core inflation remain high, weakness in the corporate sector is likely to contribute to slowing economic growth. Key inflation gauges like core services ex-shelter are also trending lower. In addition, the labor market is showing some signs of softening as metrics like the gap between job openings and unemployed persons appear to be normalizing.
  •  
  • Fed officials have been more measured in their comments since the collapse of Silicon Valley Bank, noting the effect the banking stress has had on the economy. Credit conditions for small businesses have also tightened meaningfully, contributing to headwinds for the growth outlook.
  •  
  • We believe this Fed tightening cycle is likely in its last innings, as growth is slowing, inflation is decelerating, and credit availability is becoming scarcer.
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  • With recession risk increasing, we are more cautious in portfolio positioning. We see a yield curve steepener (a position designed to benefit when short-term yields come down more quickly than long-term yields) as attractive in this market environment. Current starting valuations look compelling, and the yield curve is likely to steepen from its extremely inverted level if we enter a recession.
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  • Finally, a neutral to modestly underweight duration position can help hedge the curve positioning, particularly if inflation remains sticky and the Fed is forced to be more restrictive than we anticipate.


Ritchie Tuazon is a fixed income portfolio manager with 23 years of industry experience (as of 12/31/23 ). He holds an MBA from MIT, a master's in public administration from Harvard and a bachelor's from the University of California, Berkeley.

Timothy Ng is a fixed income portfolio manager with 17 years of investment industry experience (as of 12/31/2023). As a fixed income investment analyst, he covers U.S. Treasuries, TIPS and interest rate swaps. He holds a bachelor's degree in computer science from the University of Waterloo, Ontario.

Tom Hollenberg is a fixed income portfolio manager with 18 years of industry experience (as of 12/31/2023). As a fixed income investment analyst, he covers interest rates and options. He holds an MBA in finance from MIT and a bachelor's from Boston College.


Duration is a measure of the approximate sensitivity of a bond portfolio's value to interest rate changes. 

 

Yield curve measures the difference between the yields of bonds of different maturities. A yield curve is said to be inverted when shorter term bonds provide higher yields than longer term bonds.

 

Yield curve steepening occurs with long-term rates rising more than short-term rates, or short-term rates falling more than long-term rates.

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