Key takeaways
- The Federal Reserve’s 50 basis point rate cut indicates that inflation is nearly under control and that the Fed wants to ensure the economy stays on strong footing.
- Fed Chair Jerome Powell communicated that the Fed will follow the data and seeks to respond promptly to changes in economic conditions.
- We recommend focusing on individual credit picking or selecting companies or industries that overweighted a hard landing scenario in their valuations.
- The focus on value creation should begin to shift from rates (especially on the longer end) back into credit.
A year and a half into this historic rate hike cycle, we mark the point where the Federal Reserve Board is finally catching its breath after an exhausting fight against inflation. The risk of a weakening labor market now takes precedence over inflation, which has thankfully been cooling. In other words, the Fed believes it has enough leeway on inflation to shift its focus toward preventing the job market from sliding into more dangerous territory.
Inflation is nearly under control in a slowing but resilient economy
Although the economy is slowing, it’s still showing resilience—like a marathon runner who’s fatigued but far from collapsing. Recent data—housing starts, industrial production, retail sales and the Empire Manufacturing Index—highlight the U.S. economy’s ability to withstand tighter monetary policy. So instead of focusing on whether the cut was 25 or 50 basis points (bps), the real story is that the Fed is kicking off this easing cycle. And they’re doing it because inflation is nearly under control, not because the economy is falling off a cliff.
As for the 50-bps cut? Well, it seems like the Fed wanted to match market expectations. Was it absolutely necessary? Maybe not. But they didn’t want to underdeliver and rattle markets. Historically, the Fed avoids surprising markets on the hawkish side during cut cycles.
As the easing cycle begins, Powell emphasized that the Fed will follow the data
While we expect inflation to continue its descent, giving the Fed more room to maneuver down the line, predicting the precise magnitude and timing of future cuts is a bit of a fool’s errand. Powell emphasized that the 50-bps cut was a prudent move to jumpstart the easing cycle, while carefully balancing his message to ensure the market understands the Fed will remain data-dependent going forward.
As Powell reinforced during the press conference, the range of outcomes for both unemployment and inflation is still wide, especially with potential fiscal policy changes in 2025 on the horizon and an employment picture that’s clearly loosening.
We believe the current economic and credit climate are promising
All that said, while we believe many credit assets have already priced in a relatively benign or “soft” landing, it’s still important to reflect on the last three years and the unprecedented challenges Covid-19 created for the economy. Given all we’ve faced, the fact that we’re in a relatively stable situation as we cut rates for the first time in more than 18 months is a win for both the Fed and the markets. It’s also encouraging to see a Fed that appears more proactive—focused on not falling behind the curve. If anything stands out from the conference, it’s that Powell, who was late in starting his rate hikes, seems intent on messaging that his Fed is keen to avoid the historical pattern of past Feds being slow to react with both hikes and cuts to changing economic conditions.
Post-conference, rates are selling off, which implies much of this was already priced into the U.S. Treasury market. We expect some steepening to occur and assuming we avoid a hard landing scenario, the long end of the curve appears in a pretty good spot for valuations. Longer term—all else equal—the rate cut should be positive for credit across most fixed income asset classes. Value creation in fixed income should now refocus away from rates and into picking spots in credit where individual outcomes are mispriced or where a harder landing scenario is priced in with too much weight. We’ll keep a close eye on the data and listen carefully to what management teams are signaling for any signs of a shift.
The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change and may change based on market and other conditions and without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.
Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
Bond values fluctuate in price so the value of your investment can go down depending on market conditions.
Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.
