By David Lebovitz via Iris.xyz
Over the past few weeks, futures markets have begun pricing in an increasing chance that the Federal Reserve (Fed) will cut interest rates at its July meeting.
This has also been reflected in the cash bond market, where yields out to the 6-month maturity are currently higher than 10-year rates, and consensus expectations are for at least two rate cuts in 2019. But will the Fed really cut rates multiple times between now and the end of the year?
Those who support this idea cite the need for “insurance cuts” in the face of low inflation and downside risks to growth. However, if there are only 9 potential 25bp rate cuts between where we are and the zero bound, does it really make sense to use one-third of them when the risk of imminent recession does not appear elevated? This is something that can be debated until we are blue in the face; the more important question is what the Fed will do, rather than what the Fed should do, and how to think about portfolio construction against this backdrop.
The hurdle for three rate cuts feels a bit high, and if they are not delivered, interest rates will need to rise. As such, it likely make sense to maintain a shorter duration approach within fixed income, and simultaneously focus on parts of the credit market that offer an attractive combination of moderate interest rate sensitivity and healthier yields.
In equities, defensive sectors such as utilities and consumer staples have rallied strongly as rates have fallen; again, if the Fed fails to deliver on 3 rate cuts, investors in these sectors could feel pain as interest rates move higher. We prefer sectors such as financials and energy, which offer yields greater than the broad index but will be far less impacted by rising rates, and alternative assets such as infrastructure and transportation can provide investors with a healthy stream of income, less interest rate sensitivity, the potential for capital appreciation.
Read the full article at Iris.xyz.