The Federal Open Market Committee is expected to cut interest rates at its September meeting, which will also provide a new Summary of Economic Projections. Join us live on September 19 at 1 p.m., as Marvin Loh, senior macro strategist at State Street Global Markets, examines the meeting, the SEP and Fed Chair Powell's press conference.
Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Gary Siegel (00:10):
Hi, welcome to another Bond Buyer Leaders Forum Event. I'm your host, Bond Buyer managing editor Gary Siegel. My guest is Marvin Loh, senior macro strategist at State Street Global Markets. Today we're going to discuss monetary policy including yesterday's federal open market committee meeting. Marvin, welcome back and thank you for joining us.
Marvin Loh (00:35):
Thanks for having me. Wonderful time to be talking about the markets these days, isn't it?
Gary Siegel (00:40):
Oh, yes, it is. So was there anything in the statement, the summary of economic projections or Chair Powell's press conference that surprised you or grabbed your attention?
Marvin Loh (00:54):
It was a fascinating couple of weeks and it was certainly a fascinating FOMC meeting and really quite frankly the last couple of quarters, last couple of years has been fascinating just to see how unsure the Fed was in the transmission of policy within the economy, if you will. So for me, some of the key takeaways from the economic projections, certainly from their policy actions was one where they think that victory is at hand. I think I heard very much a victory lap coming out of Chair Powell during Jackson Hole, and really when you look at the projections and you listen to the pressor, they were ready to say inflation is done, growth is getting back exactly where they want to do it. And they were saying that a soft landing is for the most part their base case. They've been saying it for a while, but really the lack of volatility around those economic projections showed how comfortable the committee was that they've obtained a soft landing and done something that no fed really has done during a tightening cycle.
(02:11):
When I look below the surface, however, when I look at the 50 basis points and kind of where the actual dots were, when I look at the balance of risk and one of the things that the Fed provides us is where each individual member thinks the risk is to inflation, where the risk is to growth, where the risk is to unemployment, there's much less certainty under the surface. So they try to really present a unified voice that everything is great, we are doing 50 because we're going to recalibrate. We don't have to worry too much. But when you kind of look underneath the surface, there's still a lot of uncertainty and I think that uncertainty has been with the Fed really for the last several quarters,
Gary Siegel (02:56):
A lot of economists expected a 25 basis point cut and when asked Chair Powell answered that the economy's in a good place and that seemed a little odd that that was his complete explanation and they said they're not in a rush to cut rate to cut further, but they started with 50 basis points. Did you see that as a little strange?
Marvin Loh (03:25):
I did, and certainly I think most of the economists were expecting 25. A lot of the strategists like myself were expecting 25. And interestingly when you look at the 2024 dots, so remember they give us these dots, they tell us where they think fed funds are going to be at the end of the year, almost half of them thought that they should only cut 75 basis points, which in my mind from a kind of regular cadence perspective is a quarter to start a quarter in November and a quarter in December. So I'd say a lot of the committee thought that they should have been only cutting 25. There was a lot of, I'm sure cajoling to get to 50. Powell clearly wants to get to 50, but yeah, going 25 and then saying everything is fine, I'm sorry, going 50 and just saying everything is fine doesn't really strike me as making a whole lot of sense and I'm still scratching my head a little bit in terms of trying to understand all of this messaging that they tried to do In a lot of ways they tried to make everybody happy and they made nobody happy.
(04:28):
It's like one of those types of environments.
Gary Siegel (04:32):
The stock market seemed confused by the move initially rising several hundred points and falling 700 points and rising and then falling again yesterday.
Marvin Loh (04:44):
Yeah, so when I say the Fed tried to make everybody happy, made nobody happy, I guess the exception ultimately is for the equity markets, which seems to always find something to be happy about. But yeah, no, there was a lot of uncertainty because no one market pricing was fairly aggressive. We, and I think a lot of the press had been talking about how far ahead the rates market had gotten in this discussion that the Fed was really going to be looking to get to neutral in a very, very short period of time while avoiding a recession. And there's some economic theory that makes sense that they would want to do that, but given the uncertainty, and I think the uncertainty that we've seen from a Fed that was somewhat dovish at the beginning of the year, really hawkish in the middle of the year, all of a sudden got very dovish on one or two data points and now is somewhat mixed in terms of whether or not they want to be dovish and or hawkish, which is really the confusion that generated a lot of volatility, not only inequities, but to a certain degree in the rates market and in the currency markets too at the same time.
Gary Siegel (05:54):
So Marvin, you felt this was a mixed message and that there is some dissent on the panel and basically Chair Powell pushed his vision through, correct?
Marvin Loh (06:06):
Yeah, I think so. I think so. Yeah, I think so. That is a perfect way of characterizing it.
Gary Siegel (06:13):
So what was the Fed's purpose in cutting rates? Were they trying to start moving towards a normal rate or to get to neutral? Were they trying to spur the economy? Were they taking out insurance or was it something else?
Marvin Loh (06:28):
Yeah, I wouldn't argue with the start of the rate cutting process for sure, we've gone through a fairly significant change in both the inflation environment as well as the jobs market since the beginning of the year, all of it moving into favor of the Fed. So there's an equal argument as to whether or not there higher rates really had that big of an effect. The transmission of monetary policy in the US has been something that has been a bit confusing over the last couple of years during this tightening cycle, but nonetheless, we've got a jobs market that looks like it's getting close to balance. Inflation has moved towards its goals fairly aggressively and it was time to start reducing rates. I think that what we in the market really try to get from the Fed is an understanding however of the response function, what's going to drive them to either continue along this path, why are they here at this point in time and what would change that path?
(07:33):
And I didn't hear anything from Powell that really gave me a sense that they're doing anything than looking at the data, the way we're looking at the data. And I think from that perspective, we're going to have volatility around data that's either stronger than expected and or weaker than expected. And even today, Gary, one of the more high frequency data points, the weekly claims number came in lower than expected, showing that the jobs market is still on an okay footing, not necessarily consistent with the Fed that would want to go out with some of its bigger bazookas at the start of the cutting cycle and we've seen yields rise as a result of that.
Gary Siegel (08:13):
Well, obviously the economy is not in trouble and usually, like you said, they wouldn't use the bazooka unless there was some major shock. So why did they go with a half a point instead of 25 basis points? What would be the rationale?
Marvin Loh (08:30):
Yeah, I mean I agree with you fully. I don't see this economy as precipitously moving towards a recession. I do think that there is a legacy that Chair Powell is trying to preserve to a certain degree, he wants to be the only Fed that's avoided tightening into a recession, keeping that soft landing intact. There are signs historically that show that when the labor market starts to really loosen where we start to see the unemployment rate rising, which it has over the course of the last six to nine months for sure, that there is precedent that it's going to accelerate. So it's not clear cut that the economy is doing great and certainly various income groups within our demographics, the demographics in the US are struggling. So there was an absolute reason to start the normalization process. Having said that, 50 to me is one where we should see more financial stress, one where stock markets are not necessarily hitting all time highs or trending near all time highs. It's saying that things are okay and I would have rather they preserved it, but clearly there are folks on the committee that think the labor market is much worse off than the data that I'm looking at per se.
Gary Siegel (09:57):
So is the 50 basis point move an admission that they were late and that they should have moved in July?
Marvin Loh (10:04):
I think certainly there are folks on the panel that think that they are late and I think Chair Powell is one of them and I do think he strong armed a lot of the other members and the other voters to get in line with him. When we talk about whether or not they were late in July, it really requires us, I think to take a step back and look at how we got to a point where they couldn't do anything in July and remember that they started this year saying that they thought they were going to cut three times inflation data was a bit hot in the beginning of the year. Initially they had said it's probably transitory speed bumps in the disinflation story, and as we got into the spring, the inflation numbers as well as the employment numbers still looked either hot and or strong.
(10:58):
So then come June where everyone had expected them to already start the cutting process, they needed to signal that, you know what? Let's put the brakes on this cutting idea. We're going to say we're only going to cut once. So they did that only in June. So in the beginning of the year they thought three in March they said three cuts was still a good idea in June, all of a sudden everyone raised their estimates in terms of inflation, they improve their outlook on the unemployment side of things and they take out two cuts. So then we roll around in July and we have employment data which was weaker than expected, and all of a sudden there's this massive change in view and we kind of heard that in terms of Fed speak and certainly Powell opened the door to cuts in July and in Jackson Hole he kind of firmed the idea that they were going to do cuts.
(11:53):
But Gary, for us in the markets trying to really understand how the Fed and other central banks are going to approach monetary policy, it really showed that they didn't even know themselves. So for folks on the FOMC to think that they should have cut in July, which I think they do, certainly we got that in the minutes. We got that in the votes that are showing that they wanted to catch up. It's also in the mission that what they did in the middle of the year was wrong, that they shouldn't have gotten more hawkish and they locked themselves into potentially not being able to cut in July. They really gave away that optionality that we wind up talking about. So that's probably one of the bigger takeaways that I get is that yeah, we're in an ultra hyper data dependent world because the Fed really doesn't have a good sense of the reaction function and they're not presenting the path with which they're going to either continue down a 50 path or pull back. They just said everything's on the table and it really doesn't give you a lot of confidence in terms of their feel of what's going on under the hood of this economy.
Gary Siegel (13:08):
So is that another expression of their uncertainty that they won't say if the next cut will be 25 or 50, that they're leaving their options open?
Marvin Loh (13:22):
Yeah, I mean to start the normalization process to really say that we're significantly above the neutral rate if we use the tailor rule, they like to use this relationship that they have between target, the target neutral rate where inflation is relative to targets where growth is relative to targets and formulaically come up with where fed funds should be that Taylor rule says that Fed funds should be lower, but their inability to really say that we're going to continue down this path. It could be 50, it could be 25, it could be nothing is a sign to me that they're not really sure how any of this is going to evolve. So when they provide us with projections, which look great, I mean those economic projections where the unemployment rate gets to 4.4% a little bit higher than where it is now, inflation continues to gently get towards 2%. It looks great. If that is how the economy evolves, then this fed should be given credit. But when we listen to what they actually are saying from a risk perspective, we really get the sense that they don't know and aren't as comfortable as this united front that they're trying to put themselves out as
Gary Siegel (14:45):
And part of this because the data they look at is backward looking instead of forward looking.
Marvin Loh (14:53):
Yeah, for sure. I mean the cycle has been different in a lot of ways. I don't want to criticize them completely. We did go through a pandemic where we shut down the world and we were talking about remote the work from home kind of environment before that really did change productivity. It changes a lot of these economic models which are built on a more traditional framework of how the economy engages. But for sure they are struggling with understanding data and when the two most important data points inflation and the unemployment rate are as extreme as they are now, they are the most lagging indicators also. So that's really one of the challenges that they have. Data by definition, if you're only looking at unemployment and you're only looking at inflation is going to be a very lagging indicator.
Gary Siegel (15:48):
So let me sidetrack us a bit.
Marvin Loh (15:50):
Sure.
Gary Siegel (15:51):
What is your estimate of the neutral rate, Marvin, and what do you think the fed's estimate is?
Marvin Loh (15:56):
Yeah, that's a great question and it's a question that all of us need to ask because it really will frame what valuations look like in this post pandemic world. So just for your listeners background, if they don't look at the dots as closely as you and I do, so the neutral rate is in theory the rate that neither accelerates and or decelerates the economy. It's the perfect interest rate when everything is in balance. We've got jobs in balance, we've got growth at trend, and for the most part the economy is chugging along the way. All the long-term estimates expect. When we started getting estimates for the neutral rate back in the early 2010s if you will, it was 4% and through kind of the mid 2010s, particularly 20 16, 20 17 when we had really, really low inflation, very low volatility around inflation and fairly robust employment, that number got down to about two and a half percent.
(17:00):
So when we take out a 2% inflation number, you get this R star, this kind of real neutral rate if you will, that's 50 basis points and it had been there for years. And over the course of the last three meetings, or no, I'm sorry, over the course of the last three quarters, which is when the fed updates those dots, they have successively increased that neutral rate from two and a half to two six to 2 75 now to two and seven eights. So right now the fed's neutral rate has gone from two and a half to just under 3%. I think that there's scope for it to potentially be higher. So I would probably pencil in a three and a quarter type of mutual rate and then we'll really see how this fiscal and deficit plays into kind of that broader neutral rate discussion and really whether or not the jobs market is as stable as the Fed seems to want to say because we've had a lot of shifts in the whole employment landscape from a lot of retirements and immigration kind of helping that discussion and all of that is still in flux.
(18:08):
So we're seeing from the Fed in terms of uncertainty that as a group, that neutral rate is increasing after not doing anything for years and an increase in three successive meetings. It hasn't been this slow revaluation over the course of the last few years. They're still thinking about what it should be and that ultimately is the anchor with which all monetary policy is approached. They're trying to get a normal economy towards neutral, and that's really what their forward projections say now, but I don't think they know what it is and I think it's higher than this kind of two and seven eight number that they're saying it is right now.
Gary Siegel (18:47):
Well, they've always said that the neutral rate is an estimate that no one really knows what the neutral rate is. Would they be willing to cut rates below the neutral rate at any point for any reason?
Marvin Loh (19:03):
I mean quite frankly, they shouldn't unless we're in a recession or we've got liquidity issues, financial stability type of issues. And really from a projections perspective, again, kind of looking at those dots and looking at what we learned, they felt the path for Fed funds was going to be over the course of the next couple of years. They provided that yesterday. They've got us getting towards that neutral rate by 2026 and it remains unchanged there. So the market has it getting to neutral quicker at this point. So the market says the Fed could get there quicker, the market's always going to want more, however, so traders will be traders and I like to always make sure that anybody I'm talking to realizes that the market's going to push the envelope and the Fed, I think in my mind, has given the market the ability to push it by really caving in on this 50 basis point discussion, but they shouldn't.
(20:05):
In theory, that's where they should want to get to. The projections are saying that they're going to get to there within the next year and a half, if you will, and unless we're in a recession where they want to stimulate the economy or they're dealing once again with financial stability issues, if all of a sudden the repo market, short-term funding gets a little bit wonky or the fed put, if you will, in terms of stabilizing overall risky because it's starting to destabilize not only our markets, but the global markets, they certainly would consider it and I don't think that they would hesitate doing it. They've done it in the past, they've done it for an extended period in the past and to a certain degree we're dealing with a lot of the res that they've been willing to do in the past. So it might not seem as if it has a cost in the short term, but it does have longer term implications in my mind.
Gary Siegel (21:04):
Getting back to yesterday's meeting, Marvin, the Fed said it's confident that inflation is moving back to 2%, but the last CPI reading the core was plus 0.3%, which again is above the 2% target if you look at it on an annualized basis. So what happens now that the Fed has cut 50 basis points if inflation remains stubbornly above the 2% target?
Marvin Loh (21:35):
Yeah, and again, this is the response function. This is the real challenge that we have and the Fed is going to have because they're going to, if they're so ultra data dependent, they're going to wait for the data to say, oh, you know what? It's not necessarily moving in the right direction. Maybe we need to do something different and by then it's going to be too late because of the long and variable lags inflation. Inflation has done a lot this year. We can't take away any of the fact that we've inflated fairly aggressively. When we kind of look a little bit deeper, the granularity, if you will, within that pricing data, it has been good deflation that has driven a lot of the better inflation readings. So as overall spending slows down, not necessarily collapsing, and it's slowing down at lower income levels. So there's an income disparity type of issue that's starting to make its way into the economy. People are pulling back on what they could buy.
(22:38):
One of the big questions is, after the fed increased by over 500 basis points in a really, really short period of time, why didn't we have a bigger impact on prices going down? The same questions could be asked the other way. If they're cutting, are they actually going to be able, are we going to see inflation re-accelerate? Again, no one's really, really sure, but there are certain components that are important in the inflation discussion which really haven't moved around, which potentially could reignite upside inflation concerns. One of them is housing for sure. Even over the course of the last, let's say couple of months when interest rates started to come down more aggressively, we've seen mortgage rates increase. We've seen home activity increase. That's not necessarily a bad thing given how stuck the housing market is in terms of activity, but does that in and of itself create at least a short-term impulse for higher prices within that shelter housing component discussion? And if it does, it does make that inflation or disinflation back to targets more challenging. The other thing is that we do see some stickiness around what the Fed calls super core, so it's core services X housing, A lot of that is wages. Certainly wages do seem somewhat stable, but they're stable at a higher level and do we need even slower growth in order to pull that down? The Fed doesn't seem to think so, but the real answer is still probably a few quarters away.
Gary Siegel (24:21):
Like you said, monetary policy works with a lag and the Fed seems to have front loaded this cut before the election and they say that they're independent and they make their decisions without any political implications. But some people have raised the question that this doesn't look too good for their apolitical status.
Marvin Loh (24:47):
I personally don't agree with that. I do think that the FOMC takes their independence seriously. There was no way that they could do anything this meeting without upsetting someone. Once again, they try to make everyone happy that they make no one happy. That is absolutely true in Washington where nobody's ever happy ever anyway, it seems. Remember Elizabeth Warren was calling for 75 basis points. The Democrats certainly given where they are in this battle, are happier that it was 50 than 75 on the other side of the aisle. Other Republicans probably are less happy with any type of rate cut. I do think they needed to cut rates. I don't necessarily agree with the 50 even though I understand why he might've wanted to do it, but I don't think it was political. Now what becomes very, very interesting is that the next Fed meeting is right around the elections once again and granted the meeting.
(25:49):
So for you and your listeners, they're doing something that's fairly unusual. They actually moved the FOMC meeting to a Thursday rather than a Wednesday because it's right after the elections. So I think that they want to be in their seats to potentially address some instability in the markets that might arise based on these elections. But having said that, one of the things that the Fed does if it is intending to change monetary policy again, is to really signal it to the market. If the data is showing that they should do 50, but we're in the middle of this election, this very heated election process, will they actually get out there and say, the data is telling us that we should do another 50 even though we didn't get the sense that they wanted to yesterday. They very well may play a little bit more of a political angle going into the November meeting, particularly if it's close around 25 and 50 again, and we see what a horrible job they did this time around in framing that 25 versus 50 discussion. So who knows how it's going to evolve, but in terms of the Fed being independent, I am comfortable that yes, they're still an independent body. They understand really the role that they have in setting monetary policy and how important it's to remain outside of the political realm when making those decisions.
Gary Siegel (27:28):
Marvin, the monetary policy works with a lag. So if they cut 50 basis points yesterday, that won't even show up in the economy till after the election,
Marvin Loh (27:39):
Correct? Yeah, for sure. For sure, for sure. The financial markets will adjust. Of course, we know how quick all of our screens change from blue to green on every word that comes out of any of these officials. So we will have an impact in terms of overall financial conditions. But in terms of it making its way into the broader economy, yes, it takes two to three quarters and kind of getting into the end of the first quarter into the second quarter of next year is going to be critical and understanding whether or not they waited too late, quite frankly. So if we think that they should have gone in, if we think that they should have cut in July, but they ultimately hamstrung themselves because of this June hawkish pivot and they didn't know how to message it and they were really hostage to the data, we won't know if they were too late until we get to the first, second quarter of next year.
(28:35):
So yeah, there's a lot of this that's kind of going around and they're hoping that they're not too late. They framed it as a recalibration. They didn't need to be that aggressive even though they were aggressive and they're still presenting this wonderful soft landing environment. But we've experienced, all of us have experienced a lot over the last couple of years, and I just find it naive to think that it's just going to be this really autopilot type of monetary policy that they're trying to ultimately convince the markets and the world that they're on at this point.
Gary Siegel (29:11):
Yeah, nothing is ever easy.
Marvin Loh (29:13):
No, it isn't.
Gary Siegel (29:14):
So since we're talking about the election, I think we know what will happen if Donald Trump is reelected to a second term in between with Joe Biden in between, and I think we know that Harris will continue Biden's policies. How will fiscal policy or the expectation of fiscal policy play into the Fed's monetary decisions?
Marvin Loh (29:48):
It's independent from Washington. Ultimately. Granted they're tied at the hip, but monetary policy shouldn't really get involved in the fiscal discussion. They should only be involved when it involves liquidity and really how that fiscal impulse is making its way into growth and the economic data. Having said that, the one thing that we're looking at is, and we're getting a lot more discussion around it, which is fabulous, is how unsustainable all of this spending is starting to look like and the amount of treasuries that are expected to be issued over the next 10 years is something that we should all be scared about. Remember that we're going through a couple of years of pretty strong growth above trend growth, really low unemployment rates. Historically, Washington uses that as an opportunity to reduce the deficit and almost potentially generate a primary surplus if they can. And we've seen that in the past, not have primary deficits, which is the federal deficit before the interest component in the minus two to 3% range of GDP, which is what we've had over the course of the last couple of years.
(31:06):
And then when you add the interest side of things, we're at like minus four to minus 5% in an overall deficit position as a percentage of GDP during a period of really, really strong above trend growth. Now we've got the weaponization of the deficit where irrespective of a green or of a blue or red wind, they're going to spend a lot, maybe one we could say is going to spend more. Maybe one has more inflationary types of pressures, but we've got deficit issues, which if it really becomes a problem, the fed's going to need to either buy more treasury securities that's on the verge of being more of a banana republic. I think we should be concerned with that or interest rates and inflation potentially not behaving the way they expect. So right now their projections are at that inflation and interest rates really settle down over the course of the next year, year and a half.
(32:10):
If we have a lot of spending and there's a buyer strike and the markets start to really say, you know what Washington, you're not going to do anything about these deficits. We're going to be the ones that need to do something about these deficits. Then it becomes part of the problems that the Fed needs to deal with. I would tell all of us to remember that fiscal spending, which is ultimately what deficits are, is a form of growth in the economy and it's a form of potential stimulus in the economy. So as we are willing, and the Fed certainly is willing to say that inflation is done doing a victory lap around inflation, the fiscal discussion is something that we've never seen before. So I do think that that might play into a neutral rate type of discussion that is potentially higher than even what it is now, which is kind of how I get to a number that's a little bit bigger than where we are now from a neutral rate discussion.
Gary Siegel (33:08):
Let's talk about the yield curve for a bit. The two and 10 is no longer inverted. What does that tell you?
Marvin Loh (33:19):
It certainly tells me that we're at the throes of the cutting cycle, so I still think that this curve should be steeper. Historically, the re steepening of a yield curve from an inverted position generally actually reflects the start of a recession. So it's very, very different economically as well as the signaling from the yield curve this time around. I wouldn't read too much into it to be honest this time. I do think that for the investors that are able to trade it, you should continue to get a steepening of it, but the signaling that it's provided clearly over the course of the last 30 to 50 years didn't work this time. We're far from a recession based on everything that we see, but it really is a sign that the Fed is going to embark on a multi period cutting cycle and we should continue to see that steepen, sorry, the discussion around the fiscal side of things, however really influences the relationship and whether or not we steep in based on a bull case where it's just a short end that's going down faster than maybe the long end or whether or not we get the short end going down and the long end either kind of stuck around here because of all this fiscal spending and or possibly going up.
(34:49):
So do we get a bear steepening? There's a lot of those types of discussions that are still out there. So I think that in evaluating the yield curve we should be looking at whether or not we think that there's a recession indicator in there. I don't whether or not it's a bull steepening, which is really an aggressive normalization and is nicely packaged around what they could cut and the economy is still holding in there. So the long end doesn't necessarily need to come down as much as it normally would in a recession or if we've got some of these neutral rate term premium concerns out there and potentially we're steepening it both with lower short yields but potentially higher long yields, all of that is a different economic story which will play out over the course of the next couple of quarters.
Gary Siegel (35:42):
So should we even be watching the yield curve for clues about recession or was this a one-off because the covid and it just didn't work this time, but in the future it might?
Marvin Loh (35:56):
Yeah, I think there are better indicators actually to really get a sense of a recession, and a lot of these recession indicators are actually built on the shape of the curve. So remember when we started this year and even at various points in 2023, there were a hundred percent odds that we were going to get a recession in the next 12 months. And they've proved not only incorrect, but about as wrong as you could. If you think about some of the GDP estimates for the third quarter being at 3%, so I don't see a recession with the jobs market still creating jobs, but having said that, it will adjust aggressively if the data starts to come off. So it's useful to watch, but there are a lot of other probably more accurate indicators or other indicators that we could use in conjunction with the curve.
Gary Siegel (36:47):
So do you see a soft landing or is it too early to tell?
Marvin Loh (36:51):
I still think that we could get a soft landing. I do worry about a soft landing, potentially reaccelerating inflation. I don't think that it's necessarily clear that everything's going to package as well as the Fed thinks, particularly again around housing inflation, around wage inflation. But I do think that the economy's in a decent shape and the Fed starting to take off some of the restrictive policy is ultimately a good thing that needs to be done. And yeah, I think we can preserve it. I think risk assets should perform well if we have a Fed, that number one seems to be willing to get bullied around by the market. That's the other one of the takeaways that I got from yesterday, kind of the 25 versus 50, the best argument that we got for 50 wasn't the data. It was because the market was pricing it, well, the market's going to price it even more so that should support risk assets. That's kind of my very simplistic way of thinking about probably the next quarter.
Gary Siegel (37:49):
What are the biggest risks to the economy?
Marvin Loh (37:54):
Yeah, I mean for sure that the fed's response function is incorrect, that the jobs market is below the surface much worse than maybe what some of the non-farm payrolls are showing. And the Fed not only should have cut in July, but they should be really signaling that there's more concern. I don't necessarily see that, but it's certainly a risk that's out there. I think longer term, really thinking about these big balance sheets, these big central banks that are much less flexible, much less nimble to deal with things is something that creates an environment where we do get volatility. We probably get more asset bubbles and potentially more volatile financial reactions around these changes in balance sheet changes in liquidity, and really being aware that that's potentially part of your portfolio from an investor perspective. I think those are some of the bigger risks that I'm looking at.
Gary Siegel (38:58):
So what does all this mean for the bond market?
Marvin Loh (39:02):
You know what? I think that cutting cycles are a tonic for all asset classes. I do worry about how aggressively duration has outperformed already, but we're probably, since we're just starting the cutting cycle, we're going to be supported in terms of whether or not yields rise significantly versus the potential for yields to drop even more from here. I think it's easier for yields to drop, particularly as we wind up in this world where we're transitioning around data. There'll be good data points like we saw today, and then there'll be data points that say, oh, you know what? The fed's late. So the market's going to take all of that and really think, all right, well if we get enough bad data points, the fed's going to do more and they probably will elections aside in terms of that discussion. So I think that fixed income, which is underrepresented in a lot of portfolios at this point still given how aggressively the bond market repriced during the tightening cycle, given how aggressively it seemed that investors were willing to shed their fixed income exposure to go into equities to go into cash, there's still room for additional accumulation of bonds within your portfolio.
(40:21):
To me, looking at spread product either through the muni market or through the corporate markets is somewhat more attractive than just buying sovereign debts straight out, given really a lot of the discussions that we had. But there's probably a bit of tailwind as investors ultimately get back to a more neutral asset allocation around fixed income, which based on a lot of the data that we look at, which is our proprietary data around asset allocation within the State street custodial network, all of the holdings that we have is still somewhat underweight. So there's still room for more fixed income to go into these portfolios to get back to longer term averages.
Gary Siegel (41:04):
We're getting close to the end, so I'm going to take a question from the audience. Great, thank you. With the interest rates starting to decrease, do you have any advice for retirees as far as investments?
Marvin Loh (41:17):
Yeah, I mean, I certainly would be thinking about extending at this point. I don't think this cutting cycle is going to necessarily need to look as aggressive as they've had in the past. And remember when the fed cuts, it usually cuts because they made a policy mistake and were already in a recession ultimately, so they cut aggressively. This time around, we're hearing different things. I think you do have an opportunity to extend, you could still collect a decent amount income. It seems as if three to five year part of the curve, if we're looking at corporate debt, if we're looking at potentially muni debt, which would give you a better after tax type of return, is probably the most attractive if you wanted to add to that income. But yeah, it's time to start really thinking about extending and moving away from cash, which has been really the part of the income discussion that everyone has loved for the last couple of years, myself included. Just really buying one month bills and collecting five and a half percent. It's just fabulous. We've been able to do it for such a long period of time. I think we really need to expect that number to get significantly lower over the course of the next six months.
Gary Siegel (42:34):
So what questions are you getting from clients, Marvin? What are they worried about?
Marvin Loh (42:39):
They are worried about the neutral rate. They're worried about longer term where all of this shakes out. I think that this fiscal discussion, which is a little bit of a soapbox that I've been on for the last year, year and a half, is a concern that's growing. Just the amount of deficits and the funding of those deficits when the fed's balance sheet is still very, very big and other central banks are not buying as much treasuries as they've had in the past. So all of that comes together in terms of really thinking about whether or not 10 year yields can go down, even though we're in a cutting cycle. So there's a lot of that type of discussion and the 60 40 and whether or not that is as potent as it is kind of after this cycle based on a lot of the other things that I talked about. But really the fact that we ended this 30, 40 year bull market, things are supposed to ultimately get reevaluated as we start the next part of the cycle. 60 40 simplistically might not necessarily be as easy of an asset allocation strategy as it had been really over the last several decades.
Gary Siegel (43:56):
Well, we're out of time and this concludes our Leaders forum. I'd like to thank the audience and I'd like to give a special thanks to my guest, Marvin Loh, senior macro strategist at State Street Global Markets. Have a good afternoon everyone.
Marvin Loh (44:13):
Thank you, Gary.
