Markets are looking to Fed rate cuts in 2024, but with inflation still sticky, what could the timing be? MoneyTalk’s Greg Bonnell discusses with Alexandra Gorewicz, VP & Director, Active Fixed Income Portfolio Management at TD Asset Management.
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[AUDIO LOGO]
With the markets betting the US Federal Reserve is near the end of its rate-hiking cycle, investors are turning their focus to when the cuts will begin. But what does the economic data, including the latest US inflation report, tell us about the potential timeline for rate cuts? Joining us now to discuss it all, Alex Gorewicz, Vice President and Director for Active Fixed Income Portfolio Management at TD Asset Management. Alex, great to have you back on the show.
Thanks, Greg. Great to be here.
All right. We got a lot to move through. So let's start with the actual inflation report that we got. It struck me as sort of like a easy as we go kind of report. How did you read it?
I think at a headline level, I agree. So both headline inflation, which includes energy and food prices, as well as core inflation, came in line with expectations and showed continued, let's say, deceleration versus prior months and very much in line with Fed expectations if not even marginally lower. But when we look through the details, that's where some of the nuances suggest that inflation is actually a bit stickier than maybe what the Fed is hoping.
So we know Chair Powell likes to look at this notion of super core inflation where we strip out shelter or owner's equivalent rent inflation. And that print actually showed surprising resilience versus prior months, certainly came in a lot firmer than expected at 0.44, which, if you annualize that figure, it's like 5 and 1/2%. Probably not what the Fed wanted to see but also suggests that a lot of the easy disinflationary gains are behind us. And the path forward from here is starting to look a little murkier.
What would you expect then to hear from the Fed? Because they have been-- they've been warning us, right? It's not going to be a straight line down. It's going to be a hard fight. At times, I feel like the market, whether it's the equity side or the fixed-income side, the bond side, we don't really believe you. Here come the cuts, right? I mean, what can we expect in terms of messaging from the Fed?
I think part of the challenge for the Fed is that over the last couple of meetings, they were relying on tighter financial conditions to help slow down the economy a lot faster and, in turn, put more downward pressure on inflation. And that remains to be seen if that will actually happen.
But when we look at general financial conditions over the last couple of months, they've become a lot easier. And then when you couple that with better-than-expected nonfarm payrolls and, again, firmer super core inflation, it's going to make the Fed want to push back against those early rate cuts for next year that you were alluding to earlier.
It did feel like, in October, that the bond market was doing some of the heavy lifting for the Fed. I think some even Fed officials would say that, right? If you're taking a look at a 10-year Treasury yield at 5%, some of the work is being done. We've seen a pretty substantial pullback. Was that all about the bond market saying, yeah, they're done, the cuts are coming? Or are there other factors at play?
I think it was a combination of the expectations that such high interest rates would eventually slow the economy much faster. So there was a little bit of that in terms of the pullback. But then for sure, the rhetoric out of Fed members didn't help in that, oh, well, financial conditions are a lot tighter. And, therefore, we don't need to deliver more rate hikes.
And in fact, if inflation continues to decelerate the way that we've seen, we could even start thinking about rate cuts. And from there, I mean, it just enabled this rate rally to continue.
What does this tell us about 2024? I mean, we hear that rate cuts, this is a 2020-- 2024 story. How many 20s did I throw in there? You know what I mean.
I get it.
It's a next year's story, right? But the thing is next year is on the doorstep. So now people want to know, are we talking about the spring? We talk about the summer, the fall? I mean, from all of this we put it together, what do we think?
Well, then I think that's a great point because the Fed has repeatedly said, well, it's too soon to talk about 2024. Well, not anymore. Now we're in December. We're about to turn the corner into 2024. And I think at this point, it's-- they're going to have to be very careful how they talk about their expectations for 2024 because there is still a lot of uncertainty. The economic data is certainly decelerating but remains very resilient.
Even if inflation stays-- let's say around core inflation stays around current levels, again, it's still coming in line with what the Fed was expecting. So no major surprises there, which means if you think back to what their dot plot is showing, rate cuts are on the table for 2024, which is just around the corner.
How many is ultimately the question. The market expects four or so for next year to the end of next year starting in, let's say, sometime in the second quarter for sure the first full-rate cut price. But that's pretty aggressive easing when you consider that the inflation uncertainty is still really high.
What does this mean for the fixed-income investor? Because, obviously, we entered this year with an idea that perhaps the higher interest rates have done their job. We were going to start to see some easing. Didn't really play out in 2023. What do we have to think about as fixed-income investors for next year?
So in fixed income, we have a spectrum that we invest in. We have shorter bonds, let's say, 2 to 5-year maturities, and longer bonds, 10 to 30-year maturities. In the last couple of months, where we've seen interest rates come down very quickly, you've seen that fall happen almost evenly across the curve, maybe marginally skewed towards longer bonds.
But those longer bonds are ultimately going to respond to how much we're going to get in total rate cuts through the cycle whenever it turns, right? But it doesn't have to turn in the next quarter or the next two quarters like the bond market's expecting. It can turn in the next 12 to 24 months. But the point is, how many in total rate cuts will we see?
And I think right now, when we look at longer bond yields, they're sort of appropriately pricing expectations of maybe up to 200 basis points of rate cuts cumulative, which is actually on the lower end when we look at prior cutting cycles. I think what's more at risk here, if the Fed pushes back against the timing of the first rate cut, is shorter bond yields, which have also fallen a lot. I think they're more at risk of adjusting higher over the next couple of weeks or months, depending on what we get from the Fed tomorrow.
Is this then a longer-term play in fixed income? We hear about opportunities considering the rate hiking cycle that we've been through. We know we're in a restrictive territory. At some point, you're thinking this is going to work. And they're going to have to cut rates. But is it still a sort of a long-term patience game?
I think so, and I think when we look at what has happened over this past year, the fact that we're ending the year-- we're almost at the end of the year. We're ending the year with midsingle-digit type of total returns for a typical fixed-income strategy. It is actually pretty remarkable when you think about all the different paths that we've taken throughout the year to get here.
But if we post another year where you have this midsingle-digit type of returns, more yield-like or income-like returns, I think that's healthy in terms of building confidence in investors to stay invested in the asset class. I think the wild swings, both very positive returns and very negative returns, are actually longer-term destructive for investor confidence. [AUDIO LOGO]
[MUSIC PLAYING]
With the markets betting the US Federal Reserve is near the end of its rate-hiking cycle, investors are turning their focus to when the cuts will begin. But what does the economic data, including the latest US inflation report, tell us about the potential timeline for rate cuts? Joining us now to discuss it all, Alex Gorewicz, Vice President and Director for Active Fixed Income Portfolio Management at TD Asset Management. Alex, great to have you back on the show.
Thanks, Greg. Great to be here.
All right. We got a lot to move through. So let's start with the actual inflation report that we got. It struck me as sort of like a easy as we go kind of report. How did you read it?
I think at a headline level, I agree. So both headline inflation, which includes energy and food prices, as well as core inflation, came in line with expectations and showed continued, let's say, deceleration versus prior months and very much in line with Fed expectations if not even marginally lower. But when we look through the details, that's where some of the nuances suggest that inflation is actually a bit stickier than maybe what the Fed is hoping.
So we know Chair Powell likes to look at this notion of super core inflation where we strip out shelter or owner's equivalent rent inflation. And that print actually showed surprising resilience versus prior months, certainly came in a lot firmer than expected at 0.44, which, if you annualize that figure, it's like 5 and 1/2%. Probably not what the Fed wanted to see but also suggests that a lot of the easy disinflationary gains are behind us. And the path forward from here is starting to look a little murkier.
What would you expect then to hear from the Fed? Because they have been-- they've been warning us, right? It's not going to be a straight line down. It's going to be a hard fight. At times, I feel like the market, whether it's the equity side or the fixed-income side, the bond side, we don't really believe you. Here come the cuts, right? I mean, what can we expect in terms of messaging from the Fed?
I think part of the challenge for the Fed is that over the last couple of meetings, they were relying on tighter financial conditions to help slow down the economy a lot faster and, in turn, put more downward pressure on inflation. And that remains to be seen if that will actually happen.
But when we look at general financial conditions over the last couple of months, they've become a lot easier. And then when you couple that with better-than-expected nonfarm payrolls and, again, firmer super core inflation, it's going to make the Fed want to push back against those early rate cuts for next year that you were alluding to earlier.
It did feel like, in October, that the bond market was doing some of the heavy lifting for the Fed. I think some even Fed officials would say that, right? If you're taking a look at a 10-year Treasury yield at 5%, some of the work is being done. We've seen a pretty substantial pullback. Was that all about the bond market saying, yeah, they're done, the cuts are coming? Or are there other factors at play?
I think it was a combination of the expectations that such high interest rates would eventually slow the economy much faster. So there was a little bit of that in terms of the pullback. But then for sure, the rhetoric out of Fed members didn't help in that, oh, well, financial conditions are a lot tighter. And, therefore, we don't need to deliver more rate hikes.
And in fact, if inflation continues to decelerate the way that we've seen, we could even start thinking about rate cuts. And from there, I mean, it just enabled this rate rally to continue.
What does this tell us about 2024? I mean, we hear that rate cuts, this is a 2020-- 2024 story. How many 20s did I throw in there? You know what I mean.
I get it.
It's a next year's story, right? But the thing is next year is on the doorstep. So now people want to know, are we talking about the spring? We talk about the summer, the fall? I mean, from all of this we put it together, what do we think?
Well, then I think that's a great point because the Fed has repeatedly said, well, it's too soon to talk about 2024. Well, not anymore. Now we're in December. We're about to turn the corner into 2024. And I think at this point, it's-- they're going to have to be very careful how they talk about their expectations for 2024 because there is still a lot of uncertainty. The economic data is certainly decelerating but remains very resilient.
Even if inflation stays-- let's say around core inflation stays around current levels, again, it's still coming in line with what the Fed was expecting. So no major surprises there, which means if you think back to what their dot plot is showing, rate cuts are on the table for 2024, which is just around the corner.
How many is ultimately the question. The market expects four or so for next year to the end of next year starting in, let's say, sometime in the second quarter for sure the first full-rate cut price. But that's pretty aggressive easing when you consider that the inflation uncertainty is still really high.
What does this mean for the fixed-income investor? Because, obviously, we entered this year with an idea that perhaps the higher interest rates have done their job. We were going to start to see some easing. Didn't really play out in 2023. What do we have to think about as fixed-income investors for next year?
So in fixed income, we have a spectrum that we invest in. We have shorter bonds, let's say, 2 to 5-year maturities, and longer bonds, 10 to 30-year maturities. In the last couple of months, where we've seen interest rates come down very quickly, you've seen that fall happen almost evenly across the curve, maybe marginally skewed towards longer bonds.
But those longer bonds are ultimately going to respond to how much we're going to get in total rate cuts through the cycle whenever it turns, right? But it doesn't have to turn in the next quarter or the next two quarters like the bond market's expecting. It can turn in the next 12 to 24 months. But the point is, how many in total rate cuts will we see?
And I think right now, when we look at longer bond yields, they're sort of appropriately pricing expectations of maybe up to 200 basis points of rate cuts cumulative, which is actually on the lower end when we look at prior cutting cycles. I think what's more at risk here, if the Fed pushes back against the timing of the first rate cut, is shorter bond yields, which have also fallen a lot. I think they're more at risk of adjusting higher over the next couple of weeks or months, depending on what we get from the Fed tomorrow.
Is this then a longer-term play in fixed income? We hear about opportunities considering the rate hiking cycle that we've been through. We know we're in a restrictive territory. At some point, you're thinking this is going to work. And they're going to have to cut rates. But is it still a sort of a long-term patience game?
I think so, and I think when we look at what has happened over this past year, the fact that we're ending the year-- we're almost at the end of the year. We're ending the year with midsingle-digit type of total returns for a typical fixed-income strategy. It is actually pretty remarkable when you think about all the different paths that we've taken throughout the year to get here.
But if we post another year where you have this midsingle-digit type of returns, more yield-like or income-like returns, I think that's healthy in terms of building confidence in investors to stay invested in the asset class. I think the wild swings, both very positive returns and very negative returns, are actually longer-term destructive for investor confidence. [AUDIO LOGO]
[MUSIC PLAYING]