Don’t Fight the Fed
John Lekas CEO
September 22nd, 2023
“Don’t fight the Fed.” These individuals are academics, not rational business people. The good news is they will inform you of their intentions; there’s no need to second-guess them. They have stated that they are data-dependent, so let’s examine the data! It clearly indicates that they will continue to raise rates. The two inflation components are wages and prices, and the Fed assesses this primarily through the CPI and GDP deflator, both of which suggest higher rates. It seems like we can expect two more rate hikes this year, bringing the Fed funds rate to 6%. The goal is a 2% inflation/growth rate.
GDP US Deflator
US CPI
We believe that the weak dollar will persist, leading to further price inflation in commodities such as oil, gas, steel, aluminum, food, and more. Even if the Fed were to start lowering rates (which they are not), these costs could still rise significantly if the dollar falls precipitously. Labor strikes and other factors will continue to exert upward pressure on wages, regardless of the Fed’s actions. One bright spot is unemployment, which has ticked up. If unemployment reaches 5% or 6%, wages may start to stabilize or even decline, but that’s still a ways off.
I often get asked, ‘When will you extend maturities?’ My response is that we will do so when the U-3 Unemployment rate is close to 5% or when the yield curve flattens, meaning that the long-term bond yield is close to the Fed funds rate. Until then, we will keep our duration short and maintain high credit quality. We have maintained this strategy since 2020 and believe it offers the best risk-reward profile on the yield curve. Short-duration bonds present a much more favorable risk return compared to equities at this time.
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