Do U.S. Elections Preclude Fed Action and Bond Returns?
April 30, 2024
Strong economic growth and hotter inflation has led the market to reprice expectations of cuts, from an expected six cuts in 2024 (as of Jan 2024) to the current one today. Despite softer leading indicators, there are small expectations for a rate cut prior to Presidential Elections. Fed monetary action during an Election year is more common than one would think, but the start of a new cycle seldom occurs. While bond markets have now repriced this reality, weakening of leading indicators and high absolute yields are tailwinds in a path to less rate volatility and an after-Election November ‘Fed Put’.
The long and variable lags of monetary policy now sit nine months in since the last Fed rate hike. This compares to an average cycle between policy changes of 5.5 months, since 1980. The longer than average of this cycle is likely driven in part by depleting of higher COVID-era consumer cash reserves, lower cost of housing (outstanding mortgage rate of 4% vs new mortgage rate of 7.5%), and the inferred neutral interest rate sitting above Fed Funds (i.e. not enough to cool the economy).
The Fed has been steadfast in calling for material movement towards their 2% inflation target, their ‘data dependency’, while the likelihood is that inflation and labor markets will soften slowly. While the Fed has enacted policy changes in all but one election year since 1980, the majority have been a continuation of a prior year’s policy. New monetary cycle actions are elusive, with a hiking cycle in 2004 and cuts during shocks seen in 2008 and 2020. A one-off June or July rate cut may be possible, prior to Party Conventions, but rests on seeing materially weaker inflation prints in the coming months.
The current environment is a likely conundrum for the Fed as leading indicators oppose trending growth. The odds of the first rate cut now aptly sits just two days after the November elections. While current yields are up to start the year, the backdrop (Fed, macro data, oil prices and yields) are uncannily like September 2023. However, unlike the past six months, interest rate volatility is likely to fall between now and November, with range-bound yields presenting a new opportunity to extend duration. While Fed action remains low in the coming months, the ‘carry’ of 5%+ yields in sovereign bonds remain an attractive opportunity to lock in attractive yields versus the path of declining yields in floating rate cash.
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