Tag Archives: Economy

10.11.24
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That’s comforting!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The Fed’s meeting notes from the September 17-18 FOMC have recently been released. Here are a few tidbits:

Some officials warned against lowering rates “too late or too little” because this risked harming the labor market.

At the same time, other officials said cutting “too soon or too much” might stall or reverse progress on inflation.

Here’s my favorite:

Officials also don’t seem in agreement over how much downward pressure the current level of the Fed’s benchmark rate was putting on demand.

I have an idea, why don’t we just have each member of the Federal Reserve’s board of governors stick their finger in the air and see which way the economic winds are blowing. It may be just as effective as what we currently seem to be getting.

Given that the economy continues to hum along with annual GDP growth of roughly 3% and “full employment” at 4.1%, I’d suggest that having a Fed Funds Rate at 5.25%-5.50% wasn’t too constraining, if constraining at all. We’ve highlighted in this blog on many occasions the fact that US rates had been historically higher for extended periods in which both the economy and markets (equities) performed exceptionally well – see the 1990’s as one example.

Furthermore, as we’ve also highlighted, there is a conflict between current fiscal and monetary policy, as the fiscal 2024 federal deficit came in at $1.8 trillion or about $400 billion greater than the anticipated deficit at the beginning of the year. That $400 billion is significant extra stimulus that leads directly to greater demand for goods and services. How likely is it that the fiscal deficit for 2025 will be any smaller?

I believe that there are many more uncertainties that could lead to higher inflation. The geopolitical risks that reside on multiple fronts seem to have been buried at this time. Any one of those conflicts – Russia/Ukraine, Israel/rest of the Middle East, and China/Taiwan – could produce inflationary pressures, even if it just results in the US increasing the federal budget deficit to support our allies.

If just sticking one’s finger in the air doesn’t help us solve our current confusion, there is always this strategy:

10.08.24
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We Suggested That It Might Just Be Overbought

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Regular readers of this blog might recall that on September 5th we produced a post titled, “Overbought?” that suggested that bond investors had gotten ahead of themselves in anticipation of the Fed’s likely next move in rates. At that time, we highlighted that rates had moved rather dramatically already without any action by the Fed. Since May 31, 2024, US Treasury yields for both 2-year and 3-year maturities had fallen by >0.9% to 9/5. By almost any measure, US rates were not high based on long-term averages or restrictive.

Sure, relative to the historically low rates during Covid, US interest rates appeared inflated, but as I’ve pointed out in previous posts, in the decade of the 1990s, the average 10-year Treasury note yield was 6.52% ranging from a peak of 8.06% at the end of 1990 to a low of 4.65% in 1998. I mention the 1990s because it also produced one of the greatest equity market environments. Given that the current yield for the US 10-year Treasury note was only 3.74% at that point, I suggested that the present environment wasn’t too constraining. In fact, I suggested that the environment was fairly loose.

Well, as we all know, the US Federal Reserve slashed the Fed Funds Rate by 0.5% on September 18th (4.75%-5.0%). Did this action lead bond investors to plow additional assets into the market driving rates further down? NO! In fact, since the Fed’s initial rate cut, Treasury yields have risen across the yield curve with the exceptions being ultra-short Treasury bills. Furthermore, the yield curve is positively sloping from 5s to 20s.

Again, managing cash flow matching portfolios means that we don’t have to be in the interest rate guessing game, but we are all students of the markets. It was out thinking in early September that markets had gotten too far ahead of the Fed given that the US economy remained on steady footing, the labor market continued to be resilient, and inflation, at least sticky inflation, remained stubbornly high relative to the Fed’s target of 2%. Nothing has changed since then except that the US labor market seems to be gaining momentum, as jobs growth is at a nearly 6-month high and the unemployment rate has retreated to 4.1%.

There will be more gyrations in the movement of US interest rates. But anyone believing that the Fed and market participants were going to drive rates back to ridiculously low levels should probably reconsider that stance at this time.

06.25.24
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The Heavyweight Fight May Be Tilting Toward Fiscal Policy

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.

05.30.24
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A Little History Lesson is in Order

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I continue to be surprised by the constant droning that US interest rates are too high and financial conditions are too tight. Compared to what? If the reference point is Covid-19 induced levels then you are probably right, but if the comparison is to almost any other timeframe then those proclaiming that the sky is about to fall should refer to one of the greatest decades for equities in my lifetime – the 1990s. I think most investors would agree that the 1990s provided a nearly unprecedented investing environment. One in which the S&P 500 produced an 18.02% annualized performance.

Was the economic environment of the 1990s so much better than today’s? Heck no, but let’s take a closer look. The average 10-year Treasury note yield was 6.52% ranging from a peak of 8.06% at the end of 1990 to a low of 4.65% in 1998. Given that the current yield for the US 10-year Treasury note is 4.56%, I’d suggest that the present environment isn’t too constraining. Furthermore, let’s look at the employment picture from the ’90s. If US rates aren’t high by 1990 standards, unemployment must have been very low. You’d be wrong if that was your guess. In fact, unemployment in the US ranged from 7.5% at the end of 1992 to a low of 4.2% in 1999. For the decade, we had to deal with an average of 5.75% unemployment. Today, we sit with a 3.9% unemployment rate. That level doesn’t seem too constraining, and initial unemployment claims remain quite modest.

So, current US interest rates and unemployment look attractive versus what we experienced during the ’90s. It must be that economic growth was incredibly robust to support such strong equity markets. Well, again you’d be wrong. Sure economic growth averaged 3.2% during the decade, but the Atlanta Fed’s GDPNow model is forecasting a 3.5% growth rate currently for Q2’24. This comes on the heels of a rather surprising 2023 growth rate. What else could have contributed to the 1990’s successful equity market performance that isn’t evident today? How about fiscal deficits? Perhaps the US annual deficit during the ’90s contributed significant stimulus which would have led to enhanced demand for goods and services?

I don’t think that was the case either, as the cumulative US fiscal deficit of $1.336 trillion during the 1990s, including surpluses in 1998 and 1999, is roughly $400 billion less than that which occurred in fiscal 2023 and what is predicted for 2024. Oh, my. The largest fiscal deficit during the 1990s was only $290 billion. That’s equivalent to about 2 months-worth today.

I’m confused, the 1990s produced an incredible equity market despite higher rates, higher unemployment, lower GDP growth, and little to no fiscal stimulus provided by deficit spending, yet today’s environment is constraining? Come, on. Inflation remains sticky. The American worker is enjoying (finally) some real wage growth and is gainfully employed. Rates are not too high by almost any reasonable comparison. US GDP growth is forecasted to be >3%. Where is the recession? Fiscal stimulus continues to be in direct conflict with the Fed’s monetary policy. Something that those investing during the 1990s didn’t need to worry about. Taken all together, is 2024’s environment something to be concerned about, especially relative to what transpired in the 1990s? Should the Fed be looking to reduce rates? I’ll be quite surprised if they come to that conclusion anytime soon.

05.29.24
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What A Ride!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

In 1971, Bread produced the song If. The song starts off with David Gates singing the lyrics, “if a picture paints a thousand words”. Looking at the graph below, I think that Bread and David could have used a number far greater than 1,000 to describe the impact that this picture might produce.

It never ceases to amaze me how momentum builds for an idea driving perceptions to depths or altitudes not supported by the underlying fundamentals. We see it so often in our markets whether discussing bonds, equities, or alternatives. In the case above, the “Street” became convinced that the US Federal Reserve was going to have to drive US interest rates down as our economy was about to collapse. A “please do something” cry could almost be heard from market participants who thrived on nearly four decades of Fed support. They were so accustomed to the Fed stepping in anytime that there was a wobble in the markets that it became part of the investment strategy.

It got so silly, that fixed income managers drove rates down substantially from the end of October to the end of 2023. In the process, they created an environment that was once again very “easy” and supportive of economic growth. But, that wasn’t the end of the story. I can recall a near unanimous expectation that there was going to be anywhere from 4-6 cuts in the Fed Funds Rate and perhaps more during 2024. We had analysts predicting 250 – 300 bps of rate cuts. Was the world ending?

I’ve produced more than 40 blog posts since March of 2022 that used the phrase “higher for longer” in describing an economic and inflationary environment that I felt was to robust for the Fed to reduce rates. Of course, there were many more posts in which I questioned the wisdom of the deflationary and lower rates crowd where I didn’t precisely utter those three words. Well, fortunately for pension America and the American worker, the US economy has held up in far greater fashion than predicted. The labor market remains fairly robust keeping Americans working and spending.

While inflation remains sticky and elevated, US rates have remained at decade highs providing defined benefit sponsors the opportunity to take substantial risk from the plan’s asset allocation framework through asset/liability strategies (read Cash Flow Matching) that secure the promises at substantially lower cost. As the chart above highlights, expectations for rate cuts have fallen from 4-6 or more to fewer than 2 at this point, as only a -31 bps decline is currently priced in. We’ve seen quite a repricing in 2024, and I suspect that we might need to see more, as “higher for longer” seems to be the approach being taken by the Fed.

While this is the case, plan sponsors would be wise to secure as many years of promised benefits as possible. Plan sponsors and their advisors let 2000 come and go without securing the benefits only to see two major market declines sabotage the opportunity and your plan’s funded status. Riding the asset allocation rollercoaster hasn’t worked. Is the car that you are riding in nearing the peak at this time?

05.14.24
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What’s The Hurry?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

“Fed To Cut Rates in September, Say Nearly Two-thirds of Economists.”

This pronouncement was in large bold font on an email that I received this morning from the Wealth Advisor. Should I be skeptical? You bet!!

As you may recall, there was near unanimity among “economists” late last year that the US Federal Reserve would begin reducing rates RAPIDLY as the calendar flipped to 2024. In fact, consensus was fairly strong that there were going to be 4-6 cuts of between 1.0%-1.5%. There was even a leading bank that saw the need to reduce rates by 2.5% – oh, my. What happened? At this time I’m particularly interested in the 1/3 of economists that were predicting huge cuts at the end of 2023 that aren’t buying a September cut at this time. Those are the ones that I want to hear from.

What has changed from late last year when the labor market was strong, inflation was sticky, economic growth was stronger than expected, the stock market was raging ahead, and fiscal policy was in direct conflict with the Fed’s monetary objectives? Nothing has changed!

What is the urgency to cut rates? The Atlanta Fed’s GDPNow model is predicting a 4.2% annualized growth rate for Q2’24 (latest update as of May 8th). Does a growth rate of that magnitude warrant a rate cut? Heck no! Yes, there is the issue that most of today’s investors don’t remember the 1970s, if they were even born, but I do. Fed missteps lead directly to incredibly high inflation and US interest rates. Today’s rate environment is nothing compared to that era. Why risk a repeat? Stagflation became a reality. Is that something that you want to witness again?

Seniors and those living on a fixed income can finally earn some interest on their investments without having to dive into strategies that they don’t understand just to earn a little more interest. Pension plans can finally use fixed income to secure some or all of their promises to plan participants by matching bond cash flows of interest and principal with pension liabilities (benefits and expenses). Endowments and foundations can invest more cautiously knowing that they can earn a return from less risky assets that will help them achieve a return commensurate with their spending policy. This is all good stuff! Use this environment to take some of your assets off the asset allocation rollercoaster before our capital markets reach the apex of their journey. The next downward trajectory could be a doozy!

04.29.24
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How “Real” Will the Fed Get?

By: Ronald J. Ryan, CEO, Ryan ALM, Inc.

Chairman Powell and the Fed have consistently said they want real rates. The Fed primarily focuses on the Personal Consumption Expenditures (PCE) as their gauge of inflation. Currently the PCE is at 2.7%. What the Fed has not said is the target level of real rates. Historically, real rates as measured by the St. Louis Fed have averaged about 3.0% although the trend line has decreased steadily since the 1980s (see graph below). With the PCE at 2.7% today a 2% to 3% real rate would suggest a 4.70% to 5.70% 10-year Treasury nominal rate. With the 10-year Treasury at 4.66% today, it would seem that there is no reason for any cut in rates by the Fed. In fact, there may be more reason to increase rates.

The question remains… where will inflation (as measured by the PCE) level off? Who knows since there are too many factors to consider. The major causes of inflation today seem to be:

  1. Excessive Government Spending

Biden 2025 budget of $7.3 trillion is 12.3% higher than the 2024 budget of $6.5 trillion. Jamie Dimon, CEO of JP Morgan Chase, warns that excessive deficit spending is inflationary and that interest rates could spike up to 8%. The Biden Administration Student Loan forgiveness package could increase the deficit by $430 billion if successful.

  • Oil Prices

       West Texas Intermediate (WTI) Crude oil prices are up over 19% in 2024.

  • Red Sea Attacks

About 12% of global trade goes through here to the Suez Canal. Ships now have to be rerouted around southern tip of Africa creating a delay of about two weeks at a cost of $3,786 per vessel or about $1 million per week. According to Drewry World Container Index costs are up over 90% YoY.

  • Francis Scott Key Bridge Collapse

One of the largest ports in America handling $80 billion in cargo annually. Estimated closure costs = $15 million per day with closure expected for two to three years.

As always, the motto “let the buyer beware” (Caveat Emptor) seems to apply here.

04.24.24
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Tricky? Not Sure Why!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The WSJ produced an article on April 22, 2024 titled, “Path for 10-Year U.S. Treasury Yield to 5% Is Possible but Tricky” At the time of publication, the 10-year Treasury note yield was just under 4.7%. It is currently at 4.66%. Those providing commentary talked about the need to further reduce expectations for potential rate cuts of another 25 to 40 basis points. As you may recall, there were significantly greater forecasts of rate cuts at the beginning of 2024, but those have been scaled back in dramatic fashion.

Given the current inflationary landscape in which the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in March and 3.5% annually, a move toward 5% for the US 10-year Treasury note’s yield shouldn’t be surprising or tricky. According to the graph below, the US 10-year yield has averaged a “real” yield of nearly 2% (1.934%) since 1984. A 2% inflation premium would place today’s 10-year Treasury note yield at roughly 5.6%.

Given the current economic conditions (2.9% GDP growth for Q1’24) and labor market strength (3.8% unemployment rate), it certainly doesn’t seem like the Fed’s “aggressive” action elevating the Fed Funds Rate from 0 to 5.5% today has had the impact that was anticipated. Inflation in 2024 has been sticky and may in fact be increasing. Should geopolitical issues grow in magnitude, inflation may get worse. These current conditions don’t say to me that a move to a 5% 10-year Treasury note yield should be tricky at all. As a reminder, the yield on this note hit 4.99% in late October 2023. Financial conditions have not gotten more restrictive since then.

Should the Treasury yield curve ratchet higher, with the 10-year eventually eclipsing 5%, plan sponsors would have a wonderful opportunity to secure the future promised benefits at significantly reduced cost in present value terms, especially if the cash flow matching portfolio used investment grade corporate bonds with premium yields. Although US corporate bond spreads are tight relative to average spreads, they still provide a healthy premium. Don’t let this rate environment pass without taking some risk from your plan’s asset allocation. We’ve seen that scenario unfold before and the outcome is scary.

04.03.24
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What Are the Stats Telling Us?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Mark Twain quoted Benjamin Disraeli in his 1907 autobiography, when he stated “Lies, damned lies, and statistics” as a phrase used to describe the persuasive power of statistics to support weak arguments. Folks who regularly read my posts know that I am a frequent user of statistics to support my arguments, whether they are strong or weak. As a young man, I would study the sports section box scores and the backs of my baseball cards for every possible stat. It is just who I am. I love #s!

The investment management industry is inundated with statistics. You can’t go a day without a meaningful insight being shared in reference to our industry, the economy, interest rates, politics, companies, commodities, etc. I try to absorb as many of these stats as possible. However, it is easy to fall prey to confirmation bias, which humans are prone. Putting a series of statistics together and building an investment case is never easy. That said, we at Ryan ALM, Inc. have been saying since the onset of higher rates that the US Federal Reserve would likely be forced to keep rates higher for longer, as inflation would remain stickier than originally forecast.

We also didn’t see a recession on the horizon due to an incredibly strong US labor market, which continues to witness near historic lows for unemployment. Despite the retiring of the Baby Boomer generation, the labor participation rate is up marginally during this period of higher rates, indicating that more folks are looking for employment opportunities at this time. They are being supported by the fact that job openings remain quite elevated relative to pre-Covid-19 levels at roughly 880k. When people work, they spend! Wage growth recently surprised to the upside. Will demand for goods and services follow? It usually does.

Furthermore, as we’ve disclosed on many occasions, financial conditions are NOT tight despite the rapid rise in US interest rates from the depths induced by the pandemic. Long-term US rates remain below the 50-year average, and in the case of the US 10-year Treasury note, the yield difference is roughly -2.1%. Does that give the Fed some room to possibly increase rates should inflation remain elusive?

In just the past week, we’ve had oil touch $85/barrel, the Atlanta Fed’s GDPNow model increase its forecast for Q1’24 growth from 2.3% to 2.8%, a Baltimore bridge collapse that will impact shipping and create additional expense and delays, housing that once again exceeded expectations, Fed (Powell) announcements that a recession wasn’t on the horizon, job growth (ADP) that was the highest in 8 months, manufacturing that stopped contracting for the first time since 2022 (17 months), and on and on and… Am I kidding myself that our case for higher for longer is the right call? Am I only using certain stats to “confirm” the Ryan ALM argument?

We don’t know. But here is the good news. Our investment strategy doesn’t care. As cash flow matching experts, we are agnostic as to the direction of rates. Yes, higher rates mean lower costs to defease those future benefit promises, so higher rates are good. However, once we match asset cashflows of interest and principal to the liability cash flows (benefit payments and expenses), the direction of rates becomes irrelevant, as future values are not interest rate sensitive. Building an investment case for cash flow matching was challenging when rates were at historic lows. It is much easier today, as one can invest in high quality investment-grade corporate bonds and get yields in the range of 5%-5.5%, which is a significant percent of the average return on asset assumption (ROA) with much less risk and volatility of investing in equities and other alternatives.

I don’t personally see a case for the Fed to cut rates in the near future. I think that it would be a huge mistake to once again ease monetary policy before the Fed’s objective has been achieved. I lived through the ’70s and witnessed first-hand the impact on the economy when the Fed took its collective foot off the brake. As a result, I entered this industry in 1981 when the 10-year Treasury yield was at 14.9%. The Fed can’t afford to repeat the sins of the past. I believe that they know that and as a result, they won’t act impulsively this time.

03.22.24
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Are We Witnessing a Heavy Weight Fight?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Most everyone is aware that monetary policy has gotten much tighter than we’ve witnessed in multiple decades, especially on the heels of the Fed’s zero interest rate policy (ZIRP). As a reminder, the Federal Reserve began raising the Fed Funds Rate (FFR) on March 17, 2022. After 2 years of their tightening action designed to combat inflation, the Fed Funds Rate sits at 5.25%-5.5%, where it has been for the last 1/2 year. Has the Fed’s action achieved its primary objective of price stability? No, but they’ve certainly made strides toward that quest seeing inflation fall from a high of 8.4% in July 2022 to February’s 3.2% reading. Furthermore, neither the economy nor the labor force have collapsed.

I recall when the Fed first began raising the FFR, they anticipated that both the economy and labor force would be impacted. In fact, I remember seeing estimates that the unemployment rate would likely elevate to between 4.5% and 5% as a result of this action, and the economy would most likely fall into recession. Thankfully, neither event has occurred. Why? Despite the aggressive Fed action to raise interest rates, financial conditions are not that tight. In fact, as I wrote in yesterday’s post, by some measures, financial conditions are actually easier than they were before the first rate increase.

Could it be that the Federal government’s budget is the reason behind the economy and labor market’s strength despite “aggressive” monetary policy? The Office of Management and Budget (OMB) estimates that the Federal budget for fiscal year 2024 will ultimately produce a deficit of roughly $1.6 trillion. Furthermore, 2025’s budget is forecast to create a deficit of $1.8 trillion. This is incredible stimulus that is being provided to the US economy. It is in direct conflict to what the Fed is trying to accomplish. First, I don’t believe that the current level of interest rates is that high, especially by historical standards, but they definitely aren’t high enough to combat the government’s deficit spending at this time.

As a reminder, when the government deficit spends, those $s flow into the private sector in the form of income which leads to greater spending and corporate profits, which we are witnessing at this time. This conflict between monetary policy and fiscal policy is what I’m defining as the heavyweight battle. Which policy action will ultimately prevail? Back in the 1970’s monetary policy became quite aggressive leading to double digit interest rates that bled into the early 1980s. There were many factors that created the excessive inflation that ultimately had to be curtailed with unprecedented Fed action. What the Fed didn’t have to do was fight the Federal government budget.

During the 1970s, the average budget deficit was only $35 billion. Yes, that is correct. The peak deficit occurred in 1976 at $74.7 billion , while 1970’s deficit of $2.8 billion was the lowest. In case you are wondering, the $35 billion average deficit would equate to roughly $153 billion in today’s $s or <1/10th of 2024’s expected deficit. Clearly, there was little excess spending/stimulus created by the Federal government at that time for which monetary policy had to combat. So, again, the US doesn’t have a debt problem. It has an income problem! The excess stimulus is elevating economic activity, keeping workers employed and spending, while corporate America produces the goods and services that are being demanded, leading to excess profit growth that continue to fuel the stock market.

As you can see, this tug of war or heavy weight battle is far from decided. I don’t believe that US interest rates are high enough to truly impact economic activity and the labor force, which continues to enjoy sub 4% unemployment rates. We either need rates to rise more, government deficits to shrink, or a combination of both before we see the Fed achieve its goal of a 2% sustained inflation rate. Let’s pray that our very uncertain geopolitical environment doesn’t take a turn for the worse with further escalation of the Ukraine/Russia war or worse yet, conflict in Southeast Asia between China and Taiwan. Our inflation story could get much worse under those scenarios.