Is 2024 Still the Year for Fed Rate Cuts, and What's the Implication for Bond Investors?

As the global economic landscape continues to evolve, investors are closely scrutinizing the trajectory of U.S. Federal Reserve (Fed) policy in 2024 and its implications for financial markets, particularly for bond investors. The recent fluctuations in U.S. economic growth and inflation have stirred speculation about the Fed's next moves, leaving many wondering whether rate cuts are still on the horizon for this year. Some are even entertaining the idea of rate hikes. So, given this backdrop what is the Fed likely to do this year.

The first quarter of 2024 witnessed a notable slowdown in U.S. economic growth, with GDP expanding at a modest pace of 1.6%, falling short of the expectation of 2.5% and slowing from a pace of 3.4% during the previous quarter. It was also the lowest growth since the contractions in the first half of 2022. The deceleration, coupled with a surprising uptick in inflation for the quarter, reignited concerns about stagflation, where stagnant growth coincides with rising prices, casting doubt on the prospects for Fed rate cuts.

However, a subsequent pivotal inflation data report offered a slightly better picture. While core inflation derived from the personal consumption expenditure (PCE) price index eased negligibly from February to March, it remained elevated, indicating the persistence of pressures on prices. Nevertheless, this preferred measure of inflation for the Fed showed that the disinflation which began in December 2022 continued, although not enough to alleviate fears entirely nor instil the level of confidence the Fed requires to consider rate cuts. Consequently, policymakers will likely continue to exercise caution and are unlikely to ease policy rates before September. However, despite the current sticky nature of inflation, the Fed reaffirmed its view at its just concluded policy meeting that the current level of the policy rate is sufficiently restrictive, and therefore additional rate hikes are not being contemplated.

So, the current stance of the Fed remains one of maintaining the current restrictive policy for a longer duration, indicating a reluctance to reconsider rate hikes amidst the uncertain economic backdrop. The base-case scenario therefore suggests that inflation may gradually recede in the coming months, providing a window for the Fed to consider trimming rates, potentially twice in the latter half of the year.

For bond investors, this uncertainty surrounding Fed policy has translated into a choppier market environment. It has also presented more attractive entry points for bond purchases. And while a sharper rally in bond prices may not be imminent until the Fed initiates or indicates rate cuts, the potential upside outweighs the downside risks, presenting an opportunity for investors to complement money market investments with intermediate- and long-term bonds.

While it currently appears doubtful that the Fed will deliver on three rate cuts this year as it hinted as recently as March, it’s even more unlikely to resume rate hikes. So, with a high for longer interest rate backdrop and a low probability event of higher Fed rates, bond investors can continue to gradually extend duration (i.e. acquire longer-dated bonds) to their portfolio, locking in and reaping the benefits of relatively higher income for a longer period as well as strategically positioning their bond portfolios for capital appreciation once Fed rate cuts eventually materialize. Naturally, not all bonds are “created equal”, so a cautious approach to bond acquisition remains instructive, and consulting with your financial practitioner for guidance is also strongly recommended.

Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm

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