Despite the Fed’s initial pivot towards easing policy, challenges in achieving the 2% inflation target have led to uncertainty regarding the timing and extent of potential rate cuts, prompting investors to debate the outlook for monetary policy.

Fresh off a December pivot in Fed rhetoric, in which policymakers indicated that the cycle of tighter policy was over and easier policy would commence shortly, the resilient US economy and sticky inflation have delayed these best laid plans. In fact, following several first quarter economic releases, including March’s robust gain of 303,000 new jobs, core CPI remaining elevated at 3.8%, and the Employment Cost Index surprise beat of 1.2%, Powell and team found their hands entwined in a Gordian knot.

The ancient Greek legend, a prophecy in which anyone able to untie the complex knot would be destined to rule all of Asia, posed quite a challenge. After struggling to untie the elaborate knot, it is said that Alexander the Great pulled out his sword and sliced the knot in half. Having later conquered Asia, Alexander the Great fulfilled the prophecy.

The Fed’s earlier pivot to an easing bias grew problematic as confirmation that inflation is moving toward the desired 2% target remained elusive. Investors, having enthusiastically seized upon the prospects for rate cuts, moved the markets aggressively at the end of last year. However, firm economic growth and elevated price levels made it difficult to justify 6 or 7 rate cuts. Since then, expectations for rate cuts have plummeted to one or two moves later in the year. With each economic indicator, market participants continue to debate the timing and amount of potential Fed rate cuts, while Fed Chair Powell and other central bankers reiterate that policy remains restrictive and they need to be patient and await confirmation of softer inflation.

With the Fed’s hands tied, and “higher for longer” the prevailing sentiment, fixed income investors are able to enjoy higher yields and lower risks. For quite some time, the allure of short-term yields north of 5% has been compelling, leading to the successful “T-bill and chill” strategy. However, with real rates (nominal yields less inflation) at very attractive levels, coupled with the risk that higher for longer policy increases the probability of recession, investors should increase exposure to longer-term maturities. For example, with the 10-year Treasury yield at approximately 4.35%, and inflation potentially averaging 2.0-2.5% for the next ten years, investors can potentially obtain an historically attractive real return of around 2%. Current yields also create compelling risk-return dynamics over a 12-month horizon.

Interest Rate Scenario Analysis

This analysis illustrates the total return of the US Treasury security of a set maturity, over a given time period and a range of interest rate shifts

Data Source: Bloomberg as of May 15, 2024

For example, shifting the horizon yield of a 10-year US Treasury up 100 basis points results in a 12-month holding period return of -2.7%, but if rates decline 100 basis points, the horizon return should be around 12%.

Following some recent economic releases pointing to moderating prices and economic growth, including today’s lower April CPI print and the weaker than expected April jobs report, rate cut optimists have sparked a bond market rally as many investors once again adjust estimates for additional interest rate reductions. However, while the Gordian knot may have loosened modestly over the past few weeks, most Fed policymakers have been quick to preach patience as one or two softer inflation figures remain insufficient evidence that price gains are moving down to the Fed’s target. Thus, while the Fed grapples with the challenge of untying its hands and determining appropriate policy, we are capitalizing on the attractive risk-return opportunities by adding duration to our portfolios and locking in these long-term rates.

Explanatory Notes and Disclosures

Past performance is no guarantee of future results. There is no guarantee that any fund’s investment results will have a high degree of correlation to those of the Underlying Index or that any of the funds will achieve their investment objective.

F/m Investments, LLC (“F/m”) is an investment advisor registered under the Investment Advisers Act of 1940. Registration as an Investment Advisor is no indication of a level of skill or training. The information presented here in the material is general in nature and is not designed to address your investment objectives, financial situation, or particular needs. Prior to making any investment decision, you should seek advice from a professional regarding whether any particular transaction is relevant or appropriate to your individual circumstances.

The scenario above is hypothetical in nature and is designed to show the cumulative change in return in the most recently issued U.S. Treasury bonds or notes of a particular maturity for a given increase or decrease in interest rates over equal 12-month periods. The following scenario analysis is designed for informational purposes and is not an offer to buy or sell any security. The information utilized has been provided by third party vendors which are believed to be accurate at the time of use. Although taken from reliable sources, FM cannot guarantee the accuracy of information received from third parties. The information is current as of the date of this presentation and is subject to change at any time, based on market or other conditions. All investing involves risk, including the possibility of loss of original investment. You should consider the investment objectives, risks, and fees before investing. Treasury securities and the associated coupon payments are not guaranteed and are solely based on the creditworthiness of the United States Government. For specific information on the assumptions.

Treasury Bills – A Treasury bill (T-Bill) is a short-term U.S. government debt obligation backed by the Treasury Department with a maturity of one year or less A Treasury bill (T-Bill) is a short-term U.S. government debt obligation backed by the Treasury Department with a maturity of one year or less. Treasury bills are usually sold in denominations of $1,000. However, some can reach a maximum denomination of $5 million in non-competitive bids. These securities are widely regarded as low-risk and secure investments.

Treasury Bonds – Treasury bonds (T-bonds) are government debt securities issued by the U.S. Federal government that have maturities of 20 or 30 years. T-bonds earn periodic interest until maturity, at which point the owner is also paid a par amount equal to the principal.

Treasury Notes – A Treasury note (T-note for short) is a marketable U.S. government debt security with a fixed interest rate and a maturity between two and 10 years. Treasury notes are available from the government with either a competitive or noncompetitive bid.

Yield – Yield refers to how much income an investment generates, separate from the principal. It’s commonly used to refer to interest payments an investor receives on a bond or dividend payments on a stock. Yield is often expressed as a percentage, based on either the investment’s market value or purchase price.

Maturity – In finance, maturity or maturity date is the date on which the final payment is due on a loan or other financial instrument, such as a bond or term deposit, at which point the principal (and all remaining interest) is due to be paid. Interest Rates O(aka Federal Funds Rate) – The federal funds rate refers to the interest rate that banks charge other institutions for lending excess cash to them from their reserve balances on an overnight basis.

“On The Run” – On-the-run Treasuries are the most recently issued U.S. Treasury bonds or notes of a particular maturity. On-the-run Treasuries are the opposite of “off-the-run” Treasuries, which refer to Treasury securities that have been issued before the most recent issue and are still outstanding.