Until We Meet Again

We suggest paying careful attention to the fresh rounds of Fed-speak between now and the May 1st rate decision as a way to gauge the Central Bank’s acceptance of a more liberal inflation target and its commitment to the notion of a sufficiently restrictive policy. Mr. Powell and team continue to comfortably drive the policy bus and they remain securely and cautiously seated as the bus pursues its patient course. Chair Powell has made deliberate attempts to allay any concerns that the Central Bank may have over recent inflationary pressure, choosing instead to reflect an optimistic bias that policymakers are sufficiently confident that justification for an easing cycle will be met with further disinflationary evidence, despite a “sometimes bumpy road.” Furthermore, the early-in-the-year upward pricing pressure was met with a degree of dismissive reception given seasonal and technical attributions. The difficulty with making prognostications leading into this easing sequence has more to do with a unique set of circumstances that are typically not present ahead of more traditional rate cut cycles. By way of policy backdrop, the Fed has historically engineered a relaxed monetary bias in response to some type of exogenous event such as a global pandemic or a financial crisis where widespread unemployment and potentially devastating growth conditions come about. In our current situation, the Fed is seeking stable ground in support of its dual mandate as well as to establish equilibrium in the economic cycle. 

Should sustained economic growth emerge without higher inflation, there would be no urgency for the Fed to begin easing policy, yet we do believe that the key takeaways from the FOMC should set a firm table for the near-term bond market.  Our view continues to expect the first rate cut more likely in the second half of the year, but not to rule out a June move should the data points warrant earlier action. Contracts are currently pricing in about a 60% probability of a June cut, up from a closer to 50% likelihood just ahead of last week’s rate decision and presser. While we are reasonably confident of a lower funds rate this year, we are less sure as to the number of cuts. Given the divergence of the "dot-plots", it would not have taken much heavy lifting at all for policymakers to recast the median number of rate cuts down to two, indicative of lingering Central Bank concerns that an overly restrictive policy bias could place the U.S. economy into recession with a resultant tightening in financial conditions and an impediment to freely flowing credit.  

The municipal bond market continues to get caught up in its own unique world of technical considerations and relative value. Adding to the mix, we have arrived at that time of year where tax season related selling pressure comes to the muni market. The underlying demand profile that has supported muni performance on a MTD and YTD basis is likely seeing some pressure from anticipated selling of muni positions so as to cover new tax liabilities. However, such pressure is transitory given the entrenched technicals that backdrop the muni asset class. If it were not for this seasonal tax phenomenon, munis would likely be showing stronger MTD performance, yet we do think that once tax time clears, munis could revert to outperformance.