By Matthew Gaude & Shawn McGuire
Every August, the Federal Reserve Bank of Kansas City hosts dozens of central bankers, policymakers, academics, and economists from around the world at its annual economic policy symposium in Jackson Hole, Wyoming. The participants convene to discuss the economic issues, implications, and policy options pertaining to the symposium topic. The Federal Reserve Chairman usually gives a speech on a specific topic. This year, Fed Chairman Jay Powell gave a speech regarding the near-term outlook for fiscal policy and the potential to start lowering interest rates.
Some of the highlights from his speech include:
Federal Reserve Chair Jerome Powell laid the groundwork during his speech for interest-rate cuts ahead, though he declined to provide exact indications on timing or extent.
“The time has come for policy to adjust,” the central bank leader said in his much-awaited keynote address at the Fed’s annual retreat in Jackson Hole, Wyoming. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Jay Powell did note the progress on inflation and said the Fed can now turn its focus equally to the other side of its dual mandate, namely to make sure the economy stays around full employment.
“Inflation has declined significantly. The labor market is no longer overheated, and conditions are now less tight than those that prevailed before the pandemic,” Powell said. “Supply constraints have normalized. And the balance of the risks to our two mandates has changed.”
Markets are expecting the Fed to start cutting in September, though Powell made no mention of when he thinks policy easing will begin. Minutes from the July open market committee meeting, released Wednesday, noted that a “vast majority” of officials believe a September cut will be appropriate so long as there are no data surprises.
More Takeaways
Several other highlights from Powell’s speech include:
- Inflation has eased substantially but remains too high.
- Fed reasserts long-term inflation target of 2% but does not see 2% inflation this year or in 2025.
- Economic outlook is uncertain and Fed is attentive to risks, mentioning that the budget deficit is very large and unsustainable.
- The Fed’s confidence has grown that inflation is on a sustainable path back to 2 percent. Fed officials had been saying that they were waiting to gain full confidence that this was happening. It seems we are now there. “The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions.”
- “We do not seek or welcome further cooling in labor market conditions,” Powell said, adding that the slowdown in the labor market was “unmistakable.”
So, it seems the time may soon be upon us for the Federal Reserve to start lowering interest rates. The chart below is the 6-month T-Bill rate. As you can see, interest rates started declining in July in anticipation of the Fed starting to lower interest rates. The 6-month T-Bill declined from a high of 5.60% on 10/17/23 and 5.44% on 5/22/24 to the current rate of 4.87%.
Here is the chart of the 10-year Treasury Bill (similar characteristics):
What Does This Mean for Our Fixed-Income Investment Strategy?
- The first part of our strategy has been buying 3-month, 4-month, and 6-month T-Bills. As you can see in the charts above, interest rates for 3-month and 6-month T-Bills have declined from the levels of over 5.50% in October 2023 to current levels of 5.10% for 3-month and 4.87% for 6-month T-Bills. As T-Bills are redeemed, we have been reinvesting proceeds into our core fixed-income funds mentioned above.
- Intermediate-term (12-month) bonds: Since 2022, we have been purchasing high-quality bonds from banks such as J.P. Morgan, Wells Fargo, Bank of America, Citigroup, and Royal Bank of Canada. Unfortunately, there are very few quality bonds being issued currently; those days are gone. Currently, bonds such as Goldman Sachs is paying 4.60% yield, which matures in 3 years, and Bank of America is paying 5% for a 5-year maturity. The majority of the bonds we purchased in 2022 and 2023 have matured. As these bonds matured, we reinvested the proceeds into our core fixed-income funds.
Opportunities in Fixed Income
I want to revisit some insights from Howard Marks, Co-Chairman of Oaktree Capital, an alternative asset management firm with over $172 billion in assets, specializing in fixed-income and credit markets.
In October 2023, Howard Marks wrote a “Further Thoughts on Sea Change” memo. A few nuggets from this memo:
Please note, as mentioned earlier, that I’m absolutely not saying interest rates are going back to the high levels from which they’ve come. I have no reason to believe that the recession most people believe lies ahead will be severe or long-lasting. And with valuations high, but not terribly so, I don’t think a stock market collapse can reasonably be predicted. This isn’t a call for dramatically increased defensiveness. Mostly I’m just talking about a reallocation of capital, away from ownership and leverage and toward lending.
This isn’t a song I’ve sung often over the course of my career. This is the first sea change I’ve remarked on and one of the few calls I’ve made for substantially increasing investment in credit. But the bottom line I keep going back to is that credit investors can access returns today that:
- are highly competitive versus the historical returns on equities,
- exceed many investors’ required returns or actuarial assumptions, and
- are much less uncertain than equity returns.
Unless there are serious holes in my logic, I believe significant reallocation of capital toward credit is warranted.
Although we share Howard’s thoughts, we were able to find much better opportunities in late 2023 through mid 2024. Now that interest rates have declined, it is getting harder to find “opportunities” in fixed income. Keep in mind, as interest rates decline, bond prices rise. So even though we may continue to see interest rates decline, we should see a corresponding increase in bond prices, which will help our total return.
Yield Update
This leads us to provide an update as to the yields we are currently receiving from our fixed-income investments:
- Leader Capital High-Quality Income Fund: Yielding 6.45%
- Allspring Short-Term High-Income Fund: 5.94%
- Leader Short-Term High-Yield Bond Fund: 10.58%
- Fidelity Floating Rate High-Income Fund: 8.73%
- Fidelity Capital & Income Fund: 5.54%
- Janus Henderson Collateralized Loan Obligations (CLO) BBB ETF: 8.51%
From a total return perspective (dividends plus capital appreciation), following are total returns from January 1, 2024 – August 29, 2024:
We’re Here to Help
As we at Live Oak Wealth Management navigate this evolving-interest rate environment, it’s clear that strategic adjustments to our fixed-income investments are essential.
The key takeaway is that while rates may be on the decline, there remain strong opportunities in fixed income to enhance your investment strategy. By diversifying across short-term and intermediate-term bonds and carefully selecting funds that offer attractive yields, we aim to maximize both income and capital growth in this period of transition.
If you’re interested in reviewing your portfolio or discussing the impact of these shifts on your investment strategy, now is a great time to act. Click here to schedule an appointment online.
About Matthew
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
About Shawn
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER® professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc. (APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk, and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors. Seek tax advice from a tax professional. Neither APFS nor its Representatives provide tax, legal or accounting advice.