In this latest insight, Benoit Anne, Managing Director – Investment Solutions Group of MFS Investment Management – shares his thoughts ahead of the Fed meeting tomorrow and what the outcome might mean for fixed income.
‘The Fed has its work cut out. We finally got there, with macro conditions now allowing the Fed to initiate a much-anticipated easing cycle. But it may be a tad too soon for the Fed to take a victory lap.
“There is indeed a bit of anxiety that has built up following the latest labor market developments. In other words, there is little room left for further deterioration before the risk of a recession becomes a bigger worry again.
“On the inflation front, the Fed deserves some major credit, with the disinflation trajectory more established. More importantly, the Fed may have achieved what many considered to be mission impossible a year ago: engineering a soft landing. It is only the beginning of a long journey, but it is important to recognize this first cut as a supportive signal for fixed income, while also acknowledging that the Fed has more work to do.
“We are far away from the destination, namely a Fed funds rate whose big number starts with a 3, and not a 5. For this week, the market seems to be split between the chance of 25bp move and a 50bp move, with 36 bp of cuts priced in for now.
“Our Chief Economist, Erik Weisman, leans towards a 25bp cut this month (even as he thinks the Fed should go 50), but it looks like a close call. The 25bp move sounds reasonable as the Fed may want to avoid engaging in a policy action that may be interpreted as a panic signal.
“Ultimately what we believe is going to matter is the persistence and steadiness of rate cuts ahead, while also keeping the flexibility of more aggressive policy action if the macro backdrop takes a turn for the worse.
“Why is the first Fed rate cut such a big deal? For a start, it is going to cause a drop in cash returns, which may help convince cautious investors to lower their cash allocations. In addition, a switch to easing typically sends a positive signal for global risk appetite, unless it is associated with a severe growth shock. Overall, fixed income is well positioned in the period ahead, both from a duration and total return perspective as long as the tarmac continues to be soft-landing friendly.’
