Fed Puts Rate Cuts on the Table
Our fixed-income portfolio managers share their views on the Federal Reserve’s decision to keep short-term interest rates unchanged and revise lower its inflation expectations. They also explain the implications of these decisions for bond markets and investors.
The FOMC voted 9-1 on Wednesday to keep short-term interest rates unchanged on the heels of renewed trade tensions between the United States and China and concerns over slowing economic growth. The target range for the federal funds rate remains at 2.25% to 2.50%. St. Louis Fed President James Bullard was the lone dissenter at the June meeting, voting in favor of a 0.25% rate cut.
As anticipated, the FOMC removed the word “patient” from its prepared statement, which had been previously used to describe its approach to monetary policy. Many market observers believe this change is symbolic and paves the way for a potential rate cut in the coming months.
During the FOMC press conference, Fed Chairman Jerome Powell said that some FOMC members believe “the case for somewhat more accommodative monetary policy has strengthened.” While there was only one dissenting vote, eight FOMC members favor one interest-rate cut this year, he said.
The Fed’s public remarks and revised inflation projections point to an increasingly more dovish stance on monetary policy, citing weakening business sentiment, trade tensions and slower growth. The FOMC members pared some of its economic projections while others remained relatively unchanged:
- PCE inflation was trimmed to 1.5% from 1.8% in March while core PCE inflation for 2019 dropped to 1.8% from 2%.
- GDP growth for 2019 was unchanged at 2.1%. The median growth forecast for 2020 was revised up slightly to 2% while the 2021 forecast remained unchanged.
- The unemployment rate for 2019 was revised slightly downward to 3.6%, while the 2020 estimate decreased to 3.7% from 3.8%. The longer-run forecast fell to 4.2% from 4.3%.
Powell reinforced the dovish tone of the FOMC statement during the press conference. “We’re 10 years deep into an expansion and we’d like to keep it going,” Powell said. “If these risks continue to weigh on the outlook, we’re prepared to move and will use our tools to sustain the [economic] expansion.”
Overweighting Consumer and Defensive Sectors
We believe the Fed’s remarks open the door to a possible July interest-rate cut with specific language focusing on slowing economic growth, slower job growth of late but still an overall strong labor market, reduced business spending and a decline in inflation. In our view, recession risk remains lower than current bond-market pricing implies. Further, we see domestic growth remaining near its potential, while trade-war effects look more limited and the labor market seems to remain healthy.
Right now, the yield on the 10-year Treasury is approaching 2%. For fixed-income investors, we think corporate bonds still offer a reliable source of yield above Treasuries. For our taxable bond strategies, we are positioning portfolios to be dependable components of an overall asset allocation. As such, we remain focused on producing income—not overreaching for yield—and taking advantage of market opportunities. Looking ahead, we anticipate corporate bond spreads to remain flat for the remainder of the year. Generally, we’re underweighting commodities and cyclicals and overweighting consumer and defensive sectors in credit.
Inflation Comes into Focus
The Fed shifted to a more dovish tone in the FOMC statement and the comments in the news conference afterwards reinforced that position. More importantly, the Fed has shifted its primary focus to inflation from economic growth, seemingly to ease the way to an interest-rate cut later this year. In keeping with its past approach, the Fed’s decision on whether to raise rates in July will be dependent on inflation and growth data.
In market action, tax-exempt bond yields were essentially unchanged immediately following the announcement. That’s not surprising since we have seen interest rates across the yield curve rally about 0.45% to 0.70% since the end of 2018 in anticipation of a rate cut later in the year.
Tax-Exempt Municipal Bonds are issued by state and local governments as well as other governmental entities to fund projects such as building highways, hospitals, schools, and sewer systems. Interest on these bonds is generally exempt from federal taxation and may also be free of state and local taxes for investors residing in the state and/or locality where the bonds were issued. However, bonds may be subject to federal alternative minimum tax (AMT), and profits and losses on bonds may be subject to capital gains tax treatment. Municipal securities may lose their tax-exempt status if certain legal requirements are not met, or if tax laws change. The financial condition of the issuer may change over time and it is important to monitor the changes because they may affect the ability of the issuer to meet its financial obligations. The MSRB's EMMA website (www.emma.msrb.org) allows investors to sign up to receive alerts about the availability of important information that may affect their municipal bonds. The MSRB makes official statements and continuing disclosures submitted to it by issuers and others available to the public for free through its EMMA website. EMMA also provides municipal securities trade price information through its Real-time Transaction Reporting System ("RTRS") and free public access to certain municipal credit ratings. See more at: http://www.finra.org/investors/alerts/municipal-bonds_important-considerations-individual-investors#sthash.snkM0mxf.dpuf
High-yield bonds, those rated below investment grade, are not suitable for all investors. The risk of default may increase due to changes in the issuer's credit quality. Price changes will occur as a result of changes in interest rates and available market liquidity of a bond. When appropriate, these bonds should only comprise a modest portion of a portfolio.Liquidity risk refers to the risk that investors won’t find an active market for a bond, potentially preventing them from buying or selling when they want and obtaining a certain price for the bond. Many investors buy bonds to hold them rather than to trade them, so the market for a particular bond, or a small position in a bond, may not be especially liquid and quoted prices for the same bond may differ. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
© 2019 Oppenheimer Asset Management Inc. This commentary is intended for informational purposes only. The information and statistical data contained herein have been obtained from sources we believe to be reliable. Oppenheimer Investment Advisers (OIA) is a division of Oppenheimer Asset Management Inc. The opinions expressed are those of Oppenheimer Asset Management Inc. (“OAM”) and its affiliates and are subject to change without notice. No part of this presentation may be reproduced in any manner without the written permission of OAM or any of its affiliates. Any securities discussed should not be construed as a recommendation to buy or sell and there is no guarantee that these securities will be held for a client’s account nor should it be assumed that they were or will be profitable. Past performance does not guarantee future comparable results
Special Risks of Fixed Income Securities: There is a risk that the price of these securities will go down as interest rates rise. Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time. Neither OAM nor its affiliates offer tax advice. OAM is a wholly owned subsidiary of Oppenheimer Holdings Inc. which also wholly owns Oppenheimer & Co. Inc. (“Oppenheimer”), a registered broker/dealer and investment adviser. Securities are offered through Oppenheimer and will not be insured by the FDIC or other similar deposit insurance, will not be deposits or other obligations of Oppenheimer or guaranteed by any bank or other financial institution, will not be endorsed or guaranteed by Oppenheimer and will be subject to investment risks, including the possible loss of principle invested. Liquidity risk is the risk that you might not be able to buy or sell investments quickly for a price that is close to the true underlying value of the asset. When a bond is said to be liquid, there's generally an active market of investors buying and selling that type of bond. 2605089.1