We here at CWM practice and preach “cycle investing” – a time honored tradition that reflects our belief that markets and economies have defined “cycles” and that those cycles are highly influenced by monetary policy. The available and cost of credit drives investment, earnings, job growth and the like. Lack of such can obviously bring about the opposite. Understanding the Fed and likely Fed action is highly important in trying to predict the next leg of each cycle.
We have been saying for a while now that the Fed is either very, very, very close to being done with this rate hiking cycle, or that they were in fact done and we’ll all find out afterwards. As each day passes and with longer dated UST yields now elevated, the probability is quickly falling that the Fed needs to hike/will hike again. The chart below captures market data on the implied probability that the Fed will hike or cut at its meetings in the next year. There is now a zero probability for a November rate hike and just a 23% probability for a December rate hike. The market now seems to be saying (like us) that the Fed is DONE hiking. It doesn’t stop there, though. The market is now pricing in a series of Fed rate cuts in 2H24. For example, the market is now saying that by the September 2024 Fed meeting, there’s a 57% chance the Fed has cut rates almost 2x.
That’s the good news. The less good news is that with longer dated UST yields now higher, tight financial conditions keep getting tighter. The Fed just took the risk-free rate from zero to 5%, faster than at any other time in history. The Fed also just shrank the size of its balance sheet by more than $1 trillion – also never done before. The current probability of recession is beyond high, and we are of the belief that we get one this winter.
The course of action is to stay away from speculative things and speculative investing. Recessions are healthy, natural parts of cycle investing – but when you are staring one down you stay away from areas which can and do incur permanent loss (HY debt for example) and your overweight QUALITY.
Now is the time for QUALITY.
Source: Bloomberg and Jones Trading LLC as of October 31, 2023
Richard Barrett
Chief Investment Officer
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