The Federal Reserve is holding off on its interest-rate hike in June, according to Elaine Stokes at Loomis Sayles, but with inflation above the central bank’s target a strong easing cycle is not in the cards.
“We believe the Fed is going to be a little slow to cut rates,” Stokes, a senior portfolio manager at the nearly century-old investment firm, said on the What Goes Up podcast. myself here.”
Here are some highlights of the conversation, condensed and edited for clarity. To listen to the full podcast, click here or subscribe below on Apple Podcasts, Spotify, or wherever you listen.
Q: You keep a close eye on the credit markets and there has been a lot of talk lately about a possible credit crunch. I’m curious how you’re thinking about macro conditions for credit right now.
A: That’s the big question today, and we feel like what’s happened and what we’re really seeing with this banking turmoil is that we’ve seen a proof point that all these moves by the Fed ultimately are working. But they are working into people’s risk appetite for things like new technology, crypto, even some private equity. But we are not seeing it in our daily life. We’re not seeing it to the extent that you would expect to see it in normal day-to-day lending. If equity markets continue to tell us that regional banks are not safe, then regional banks, and banks in general, will continue to tighten their standards. And it’s going to start affecting those small and medium-sized businesses.
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And this is one place in which we haven’t started to see pain yet. And if it does, I think we all have a different view of what a recession will look like. We do not have a weak bank market. We have strong banks, and it’s a trust game, and we need to do something to undermine that trust — or it’s going to start affecting the economy.
Q: It all comes back to interest rates and the path for the Fed this year. What’s your big picture view on where the Fed and the rates market is headed?
A: Because of what’s happening with regional banks and the debt-limit talks, I think the Fed will absolutely hold off at its next meeting. But over the longer term, our view is that there are some big-picture secular trends that are going to keep inflation high — not necessarily above 5%, but I think that’s really the target to be achieved. It would be really difficult. We believe the Fed is going to be a little slow to respond to a rate cut. We think the market is a little ahead of itself here. I think the market is pricing in one of those first two short-term commodities that is going terribly wrong, and the Fed really has to cut.
There we have what we refer to as the four D’s – we have demographics working against us, we have de-globalization working against us, we have de-carbonization working against us, and the deficit is mounting. . We have those four things that we are all familiar with that are potentially inflationary. And it’s going to be hard for the Fed to completely take its foot off the pedal. It doesn’t look like a strong bite circle is in our future.
Q: Where are you seeing value in fixed income?
A: What I love about fixed income is you kind of have to triangulate. We have over 5% in the short end, less than 2% in the short end. And for the last several years, any 5% of us would look at that as a wow, that’s a pretty healthy return. Let’s not forget that inflation is still around 5%. Then if you take on more risk, add in the higher yield, we’re talking about 8.5% to 9%-returns. So it’s really tempting. So the yield levels get really interesting. Spreads have also become much wider than a year ago. We’ve almost doubled in the diffusion levels we get from our trunks. So it means that we are being paid a large premium for taking some risk.
Is it enough to make it seem like we’re getting paid as if we’re in a recession or recession? not enough. But the difference right now is that the dollar is worth less. We’ve lived in a market where dollar prices for bonds have been equal for a very, very long time. And now we are seeing dollar prices that the index is averaging close to 90 cents on the dollar. So not only can you buy that bond at 5% or 8.5%, but you also have the ability to go up those 10 price points if there’s positive economic news or specific news.
So when I look at all three together and really think about technicals in the market — and when I talk about technicals in the market, what I’m really talking about is the issuance crunch — We’ve had a very, very low level of issuance over the last few years. Lenders have become private and this has resulted in a big difference in the number of buyers looking for a product across markets. So when I consider all of that together, I think there is value in this market and it’s on the short end, yes. But we can also go down the risk spectrum a bit and pick up some nice low-dollar value bonds that have the potential to go into very high yields.
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