The Federal Reserve took no action on interest rates at its monthly meeting on Wednesday, keeping the central bank’s key short-term rate at 5.25% to 5.5%.
Of course, that’s where it’s been since last July, so despite all the conversation and consternation on Wall Street, there really hasn’t been much action down in Washington.
Eventually that will change and the Fed will make a move one way or the other. In the meantime, however, financial advisors still have to manage their client portfolios on a daily basis.
“Even if I knew exactly when the Fed would start lowering rates, I would also need to know how far they were going to cut rates, how quickly they would cut rates, and the broader context of the economic and market conditions at the time they were cutting rates,” said Jonathan Swanburg, president of TSA Wealth Management. “Given that these other variables will always be entirely unknowable in advance, our best option is to simply execute our long-term strategy.”
For the record, Swanburg said he believes the Fed will begin cutting rates “later this summer,” but quickly added that whenever they start lowering rates “it won’t impact our strategy.”
Stephen Kolano, chief investment officer at Integrated Partners, says his base case for interest rate actions is a single 25 basis point cut in 2024 with zero cuts not out of the question. In his view, between the most recent labor reports, retail sales, PCE and CPI reports, the risk of inflation persisting at levels higher than target for a longer period of time than current market consensus is increasing in probability.
Based on this “higher for longer” interest rate forecast, he is focusing more on equity valuations that are placed on expected earnings, paying increased attention to downside pressure on multiples.
“Given earnings estimates have remained stable, we perceive much of the equity market activity taking place as valuation driven,” said Kolano.
On the fixed income side, Kolano says he prefers shorter duration over longer points on the curve.
“While the longer end of the curve appears fairly valued in relation to current levels of inflation and economic growth, we see better probability in the medium term of the shorter end drifting down in the event of rate cuts than we view the risk of longer dated yields drifting higher,” said Kolano.
Jake Miller, co-founder and chief solutions officer at Opto Investments, meanwhile, believes that market reactions often hinge more on shifts in Fed expectations than on actual policy changes. Recently, these expectations have fluctuated significantly, essentially tightening monetary conditions preemptively in his view.
“Amidst signs of stagflation, the Fed is likely to maintain rates while adopting a hawkish tone. This will recalibrate market expectations, potentially dampening all asset classes,” said Miller.
Miller too recommends shortening duration and investing in opportunities for robust alpha generation, which are less sensitive to interest rates.
“Rather than trying to outsmart the Fed, focus on building portfolios capable of withstanding both rate hikes and cuts. In today's environment of heightened inflation and rate risk, this approach is prudent, as these risks typically don't reward investors over time,” said Miller.
Rusty Vanneman, chief investment officer at Orion Wealth Management, is also squarely in the higher for longer camp due to stubbornly high inflation and better than expected economic growth. But he believes it is prudent to start considering that the Fed’s next move could be a rate hike instead of a rate cut.
“This seems like a reasonable expectation if inflation and economic growth continue to move higher, especially if the stock market handles the more likely than not higher long term interest rates relatively well,” said Vanneman.
Vanneman added: “The level and trend of interest rates are inputs in our asset allocation views. We don’t directly use the Fed’s outlook for our investment decisions, but how the markets respond to the Fed’s outlook could provide us opportunities to make portfolio adjustments.”
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