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By Guest Blogger Doug Rowat
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Does the US Federal Reserve ever just cut rates once and then sit on the fence?
The short answer: never.
Going back some 35 years, the Fed’s easing cycles have looked like this:
- 1989-1994: 23 benchmark overnight-rate cuts
- 1995-1998 (briefly interrupted by 1 rate hike): 6 rate cuts
- 2001-2003: 13 rate cuts
- 2007-2009: 10 rate cut
- 2019-2020: 5 rate cuts
So, while it’s certainly possible that we could have a ‘one and done’ easing scenario, it’s not likely. While the current wait for the Fed’s first cut has so far seemed endless, that first cut is still likely to occur this year, and once it’s under its belt, the runway probably opens up for several more. The CME Group’s Fed Watch Tool currently pegs a 67% chance of a 25 bp cut (or more) at the Fed’s September meeting.
This preamble brings me to the bond market.
As I’ve pointed out before, equities and bonds have been positively correlated for a number of years. The Fed’s 11 rate increases beginning in early 2022 assured that equities and bonds would both fall together, but the potential for rate cuts suggests that they could also rise together as lower rates likely benefit both asset classes.
Equities, of course, have already been moving higher driven by stabilizing inflation and a recovery in US corporate earnings (this earnings season is likely to mark the third straight quarter of positive S&P 500 earnings growth). But bond prices have yet to gain much traction as the reality that we could have higher interest rates for longer than markets initially anticipated is setting in. The 67% chance of a rate cut at the Fed’s September meeting, for instance, once applied to the Fed’s June meeting. Now almost no one expects a rate cut in June.
US 10-year Treasury yields, as a fixed income proxy, have risen more than 70 bps since the start of the year. A few years ago, 0.70% would have been an attractive overall yield for a 10-year Treasury. Now it’s just the y-t-d yield change. So has the reaction of the bond market to possible Fed delays been excessive? Can investors lock in better yields now with the opportunity for further bond price-appreciation once the Fed starts cutting?
If Fed rate hiking is, in fact, over (it’s been about nine months since its last rate increase) and easing is next, it bodes well for bond returns (and equity returns, albeit with much more volatility):
3-year risk-adjusted returns for bonds and equities following last Fed rate hike
Source: Morningstar, Bloomberg, S&P. Bonds represent Bloomberg US Aggregate Bond Index and stocks represent S&P 500. Chart tracks returns following the end of the past seven Fed rate hike cycles.
The timing of rate cuts has, of course, been the million-dollar question for bond investors this year. But, examined more broadly, is the exact timing even relevant? The US 10-year Treasury yield, again as a proxy for all bond yields, is at roughly 17-year highs, so investors are being offered, at least based on recent history, very attractive yields. Assuming you believe Fed interest rate cuts will occur sometime in the next 6-9 months, holding bonds offers not only the present attractive yields but also effectively a free option on the Fed’s interest-rate policy. Future Fed rate cuts will almost certainly bring bond price-appreciation.
Bonds were a disaster for investors in 2022, but since then, even with all the recent Fed-related hand-wringing, they’ve performed reasonably well. The Bloomberg US Aggregate Bond Index, a benchmark of US investment-grade bonds, advanced about 5.5% last year on a total-return basis and is down only about half a percent y-t-d. Not Magnificent 7–level returns, but not terrible.
If you combine the recently more attractive yields with the probability (albeit not the certainty) of Fed rate cuts at some point this year, bonds still offer, in our view, compelling value.
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.
A month ago mortgage brokers were whispering to borrowers that they should go VRM. ‘Mortgage rates are coming down bigly in ’24,’ they said. ‘Take the variable rate and you’ll win.’ Even though the advice meant paying a sizeable premium for a year or so.
Well, that was ancient history.
Now homebuyers hunting for a fixed mortgage should, “lock that rate in like it’s the last lifeboat on the Titanic,” says mortgage lender, blogger and digital dude Rob McLister. In fact it looks like the price of a five-year loan is going to be higher next week – which suggests Rutting Season 2024 for the house-humpers may turn into the same damp, limp thing that crawled out of last Spring.
What happened?
Well, first, here are the latest odds on what the Bank of Canada will do next, now that bond yields are snaking higher on the back of surprising US data. Traders are pricing in two cuts for our CB this year, down from three.
The implied odds are 61% that Tiff will chop a quarter point off the current 5% policy rate in June. The chances of rates in general being a half-point lower by September have declined to 41%. Then the betting is 71% a third cut will take place by March, with a full 1% decline not happening until December – of 2025.
Yup, higher for longer.
Meanwhile, what about the Fed? After all, our bank generally follows the American one over 90% of the time, so data from south of the border must be seriously considered. After yesterday’s stats dump in Washington, traders see the first cut in that country being pushed back to this December. Yes, after the historic, explosive and globally-critical American presidential election.
We now know the US economy cooled faster than Chrystia’s popularity in the first quarter. Growth of over 3% in late 2023 crumbled to just 1.6% this year. Meanwhile core inflation went up. On one hand the drop in growth shows the Fed’s higher-rate policy is working in dampening consumer demand and piddling all over the real estate market. But on the other, says BMO Economics, “work to vanquish the inflation monster is nowhere near complete.”
Canada is not the only place where housing angst bubbles over. The average long-term US mortgage rate has jumped again over the pivotal 7% mark – now at 7.17%, compared with 6.4% a year ago and 5.1% two years ago. These are for thirty-year loans, while Canadians must renew theirs at current pricing every five years or less.
And though we little beavers dream of 30-year rate lock-ins, those decades-long loans are directly responsible for a dearth of listings and higher prices than would otherwise be the case. “That large gap between rates now and then has helped limit the number of previously occupied homes on the market,” US reports explain, “because many homeowners who bought or refinanced more than two years ago are reluctant to sell and give up their fixed-rate mortgages below 3% or 4% — a trend real estate experts refer to as the “lock-in” effect.”
In Canada we see similar fears at work. Homeowners are reluctant to list and sell, since they’ll be forced into buying at near-peak prices and at rates which have effectively tripled since Covid. The inventory of available new and resale homes continues to climb – as it does every Spring – but at a slower pace than normal, and now amid decreasing demand. Next week’s bump-up in fixed mortgage rates will simply disqualify more potential buyers.
Moreover, we’re hearing reports of ‘chaos’ and ‘panic’ in cottage country since the federal budget’s capital gains tax bomb last Tuesday afternoon. People who have owned secondary or recreational properties for years – or decades – with serious jumps in valuations, are now subject to an inclusion rate of 67% above $250,000 (and 50% below that threshold), after the June deadline.
Lots of them are bailing, hoping to minimize the tax pain. In the city, realtors expect to see a similar tsunami of listings as people flee from investment (rental) units that have gained in taxable value. Besides, who wants to be a landlord anymore when tenants stop paying rent, refuse to move, cannot be evicted, and it takes a year for bureaucracy to react?
Well, it’s a mess. Soon we will move into the next phase. More ugly coming.
Stay liquid.
About the picture: “Here you go, Garth,” writes Larry. “A couple of dogs really roughing it. On the couch we have Elsa (yes named after the character in frozen) a mix of Berneses and Great Pyrenees and 9 yrs old. On the floor we have Luna, a 7 yr old rescue dog. Both ladies enjoying life.”
To be in touch or send a picture of your beast, email to ‘[email protected]’.
