The Fed cut rates, but the market expects more: As expected the Federal Reserve lowered its target range for the Federal Funds rate by 25 basis, and now the market anticipates as many as three more cuts by the end of 2020. We think that is too much. In our view, the Fed is likely to pause to monitor the effects of the rate cuts on the economy, before acting again.
Temporary stress in the repo market: While a sudden pullback in liquidity and its impact on the short-term repo markets is not a new occurrence, the magnitude of this event was greater than recent episodes. In our view, it is likely the FOMC will resume trend growth of its balance sheet as early as November of this year.
US rate outlook: We view the Fed’s current easing as a mid-cycle adjustment and expect the US Treasuries to move in a trading range in the short-term, with limited upside in yields expected in the next six months. But we could see some upward pressure in yields, should growth proves more resilient than expected.
Investment implications: On duration, we believe that interest rate duration exposure in US fixed income should be limited. The strength of the services sector, the consumer, and small businesses support a view of higher US rates and a more reserved Fed. That said, we recognize the benefit of US Treasuries as a hedge in a risk-off environment. We view it appropriate for fixed income investors to seek opportunities across multiple sectors, move up in quality, and maintain a relatively modest risk stance. Taking exposure to securitized credit sectors, such as asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities, is consistent with this approach.
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