By: Russ Kamp, Managing Director, Ryan ALM, Inc.
You may recall that on March 22, 2024, I produced a post titled, “Are We Witnessing A Heavyweight Fight?”. The gist of the blog post was the conflict between the Fed’s desire to drive down rates through monetary policy and the Federal government’s ongoing deficit spending. At the time of publication, the OMB was forecasting a $1.6 trillion deficit for fiscal year 2024. As I noted in a post on Linkedin.com this morning, the budget office has revised its forecast that now has 2024’s fiscal deficit at $2.0 trillion.
This additional $400 billion in deficit spending will likely create additional demand for goods and services leading to a continuing struggle for the Fed and the FOMC, as they struggle to contain inflation. I also reported yesterday that rental expenses had risen 5.4% on an annual basis through May 31, 2024. Given the 32% weight of rents on the Consumer Price Index (CPI), I find it hard to believe that the Fed will be successful anytime soon in driving down inflation to their 2% target.
As a result, we believe that US interest rates are likely to remain at elevated levels to where they’ve been for the past couple of decades. These higher levels provide pension plan sponsors the opportunity to use bonds to de-risk their pension plans by securing the promised benefit payments through a defeasement strategy (cash flow matching). Furthermore, higher rates provide an opportunity for savers to finally realize some income from their fixed income investments. So, higher rates aren’t all bad! I would suggest (argue) that rates have yet to achieve a level that is constraining economic activity. Just look at the Atlanta Fed’s GDPNow model and its 3.0% annualized Real GDP forecast for Q2’24. Does that suggest a recessionary environment to you?
For those investors that have only lived through protracted periods of falling rates and/or an accommodative Federal Reserve, this time may be very different. Forecasts of Fed easing considerably throughout 2024 have proven to be quite premature. As I stated this morning, “investors” should seriously consider a different outcome for the remainder of 2024 then they went into this year expecting.