Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Macro Digest: Taking profits as Fed falters
Steen Jakobsen
Chief Investment Officer
Summary: The macro slowdown is no longer 'incoming', it's here. Not only that, but the Federal Reserve is seriously behind the curve, and appears to operating in a state of deep denial.
Action: Take profit on the long NASDAQ from earlier this week (7,300 versus 7,014). Our new position is neutral
Why it matters: The slowdown in macroeconomic data is now no longer “incoming” – it’s here now, in the present tense, and this means that the “buy the dip, courtesy of the Federal Reserve“ risk narrative is no longer sufficient. The Fed is seriously behind the curve, and it's in deep denial as well.
Context: If the market is simply pricing in an adjustment to lower rates, then investors should and will buy the market. This only confirms that the Fed is cutting rates by June. If the market gets the feeling, however, that the Fed is behind the curve and we are at risk of an actual recession, then this is a major sell signal.
The math: Assume a 50% probability of recession during Q3 or Q4; the average drop from peak to trough is 50% in recession. Further assume that there is 20% upside for the balance of this year.
Given these figures, weighted risk is as follows:
Upside: 10% expected return (50% * 20%)
Downside: 25% expected negative return (50% * 50%)
More simply, we see 10% in upside potential with a negative 25% risk at present. It's not a great risk/reward ratio.
Why it matters: The slowdown in macroeconomic data is now no longer “incoming” – it’s here now, in the present tense, and this means that the “buy the dip, courtesy of the Federal Reserve“ risk narrative is no longer sufficient. The Fed is seriously behind the curve, and it's in deep denial as well.
Context: If the market is simply pricing in an adjustment to lower rates, then investors should and will buy the market. This only confirms that the Fed is cutting rates by June. If the market gets the feeling, however, that the Fed is behind the curve and we are at risk of an actual recession, then this is a major sell signal.
The math: Assume a 50% probability of recession during Q3 or Q4; the average drop from peak to trough is 50% in recession. Further assume that there is 20% upside for the balance of this year.
Given these figures, weighted risk is as follows:
Upside: 10% expected return (50% * 20%)
Downside: 25% expected negative return (50% * 50%)
More simply, we see 10% in upside potential with a negative 25% risk at present. It's not a great risk/reward ratio.
We continue to be surprised by just how deeply the Fed has buried its head in the sand. New York Fed President Williams is the second-most important vote on the Federal Reserve board and he stated yesterday that the outlook for the US economy remains solid while acknowledging that risks are rising and that investors expect the central bank to lower interest rates in response:
“My baseline is a very good one but at the same time we obviously, as always, need to be prepared to adjust our views,” said Williams, answering questions from a moderator and the audience following a speech in New York on Thursday.
“My baseline is a very good one but at the same time we obviously, as always, need to be prepared to adjust our views,” said Williams, answering questions from a moderator and the audience following a speech in New York on Thursday.
Williams then made a bad situation worse with the below statement; the only phrase that comes to mind here is 'willful ignorance'.
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