Putting the Fed Rate Cut in Perspective
Post-FOMC Analysis
Our fixed-income portfolio managers share their views on the FOMC’s decision to cut short-term interest rates for the second time this year and raise its economic projections for 2019 and 2020. They also explain the implications of these decisions for bond markets and investors.
The FOMC voted 7-3 to cut short-term interest rates Wednesday and revised economic projections slightly higher. The federal funds rate now stands at 1.75% to 2%. Among the dissenters was James Bullard, who favored to lower the target range for the federal funds rate to 1.5% to 1.75%. Meanwhile, Esther George and Eric Rosengren preferred to maintain the target range at 2% to 2.25%.
Central bankers cited trade uncertainty, weaker global growth and muted inflation pressures as the key drivers for its policy action. “Since the middle of last year, the global growth outlook has weakened, notably in Europe and China,” Fed Chairman Jerome Powell said in a prepared statement. “Additionally, a number of geopolitical risks, including Brexit, remain unresolved. Trade policy tensions have waxed and waned and elevated uncertainty is weighing on U.S. investment and exports.”
Perhaps more meaningful that the policy move itself was the reassurance that the latest rate cut is not part of a larger effort to push rates lower, rather a “mid-cycle adjustment” to sustain economic expansion. In fact, the latest “dot plot” reveals a median forecast of no further rate cuts in 2019 or 2020, which is followed by one rate increase in 2021 and another hike in 2022.
While acknowledging weakening economic conditions, Powell believes this year’s rate cuts should provide insurance against ongoing risks. Indeed, that sentiment was reflected in the FOMC’s updated economic projections:
- GDP growth: The Fed expects GDP growth of 2.2% in 2019, an increase from the 2.1% forecast at its June meeting. For 2020 and 2021, the Fed sees GDP growth of 2% in 2020 and 1.9% in 2021. Specifically, Powell noted that household spending—which drives about 70% of growth—is “rising at a strong pace.”
- Unemployment: The median projection for unemployment in 2019 and 2020 is now 3.7%, followed by a modest rise in 2021. The 2019 forecast is a slight increase from 3.6% published in June.
- Inflation: The Fed maintained its June forecast for inflation in 2019 at 1.5%, with expectations for a rise to 1.9% in 2020 and 2% in 2021.
Overweighting Consumer and Defensive Sectors
U.S. economic growth continues to muddle along at a slightly slower pace but, in our view, recession risk remains low over the near term. The labor market remains healthy. Trade policy and additional Fed moves remain the biggest question marks. Overall, our strategy remains unchanged in this low interest rate environment.
For fixed-income investors, corporate bonds still offer a reliable source of yield above U.S. Treasuries. As always, we’re positioning portfolios to be dependable components of an overall asset allocation. Right now, we remain focused on producing income, not overreaching for yield, and taking advantage of attractive market opportunities.
Looking ahead, we anticipate corporate bond spreads will remain flat for the remainder of the year. In credit, we’re underweighting commodities and cyclicals and overweighting consumer and defensive sectors. The preservation of capital is still our foremost objective when investing in investment-grade bonds. Our bottom-up investment process and research focus helps us identify relative value opportunities in both investment-grade and high-yield bonds.
Lower Rates for the Next Year?
So far, the municipal bond market has had very little reaction to the Fed’s decision to lower rates. Over the last few weeks, interest rates have risen as the market has sought equilibrium commensurate to strong economic growth and a cautious and divided Fed. Further rate cuts are not a certainty and will be dependent on economic data and an assessment of the risk picture.
In the wake the latest policy move, we’re not changing our portfolio positioning, which is structured for lower short-term rates over the next 12 months with a Fed that favors a gradual monetary easing.
Oppenheimer’s fixed-income portfolio managers
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Tax-Exempt Fixed Income
Kathy Krieg, Senior Portfolio Manager
Ozan Volkan, Senior Portfolio Manager -
Taxable Fixed Income
Leo Dierckman, Senior Portfolio Manager
Michael Richman, Senior Portfolio Manager
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High-yield bonds, those rated below investment grade, are not suitable for all investors. The risk of default may increase due to changes in the issuer's credit quality. Price changes will occur as a result of changes in interest rates and available market liquidity of a bond. When appropriate, these bonds should only comprise a modest portion of a portfolio. Liquidity risk refers to the risk that investors won’t find an active market for a bond, potentially preventing them from buying or selling when they want and obtaining a certain price for the bond. Many investors buy bonds to hold them rather than to trade them, so the market for a particular bond, or a small position in a bond, may not be especially liquid and quoted prices for the same bond may differ. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
Special Risks of Fixed Income Securities: There is a risk that the price of these securities will go down as interest rates rise. The risks associated with investing in fixed income also include liquidity risk (the risk of not being able to buy or sell investments quickly for a price that is close to the true underlying value of the asset). Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time. OAM is a wholly owned subsidiary of Oppenheimer Holdings Inc. which also wholly owns Oppenheimer & Co. Inc. (“Oppenheimer”), a registered broker/dealer and investment adviser. Securities are offered through Oppenheimer and will not be insured by the FDIC or other similar deposit insurance, will not be deposits or other obligations of Oppenheimer or guaranteed by any bank or other financial institution, will not be endorsed or guaranteed by Oppenheimer and will be subject to investment risks, including the possible loss of principle invested. 2736896.1