Monetary Policy Changes

The Fed has taken a significant step by officially initiating its cutting cycle, which holds profound implications for the financial world. ⚠️The #FOMC has cut the FFR by 50 Basis Points to a 4.75%-5% Range. ⚠️The latest projection of the Neutral Rate, R*, came in at 2.8% versus the previous estimation of 2.9% A cutting cycle might affect other central banks' stance on monetary policy because the US Dollar could devalue considerably going into 2025, making exports from other countries like Japan more expensive. For the past two weeks, business media has made a huge story out of a 25—or 50-basis point cut, but in my opinion, today's decision on the magnitude of the cut is meaningless. Financial conditions have eased considerably since July, so it should not be a surprise that the US economy might have already started to re-accelerate. The Atlanta Fed GDPNow is flashing a Real Growth Rate of 3% for the US Economy. If that materializes, it would mean that the US #Economy is already running 1% above its potential. Why financial conditions have already started to ease? Here are some examples: ✍️Mortgage Rates decreased from 7% in July to 6.15% today ✍️The 2-Year Yield decreased from 4.75% in July to 3.63% today ✍️The 5-Year Yield decreased from 4.06% in July to 3.47% today ✍️Housing Starts have picked up momentum What market participants have priced out is a resurgence of inflation during 2025. That scenario is entirely possible if the Dollar Index drops below 100. A cheaper dollar will make commodities and import prices more expensive for the US consumer, and a reduction in real income could squeeze even more of the low to middle class into the USA. Considering the decrease in US Treasuries for the past two months, I find US Government Bonds expensive across the yield curve at these levels. I think R* is well above what the Fed estimates because of factors like de-globalization, the reshoring of strategic industries, and increased protectionism. The terminal rate post-pandemic is between 3.5% and 4%, in my opinion, and that is where I think this cutting cycle will end. If I am proven right, bond investors must reprice government bond yields higher. How do we play a potential increase in inflation in a no-landing scenario? I tilted my portfolio as I outline here below: 👉Tilt the portfolio to over-weight energy and miners. 👉Have a marginal exposure to Gold and Silver. 👉Favor TIPs over US Treasuries 👉Increase allocation to US Value Stocks and International Stocks. 👉Lock-In US Investment Grade Credit at the belly of the yield curve where we can still get 4.8% to 5% yields, especially on issues at the Single-A Rating Enjoy the ride! #Finance #InterestRates #Economy #Investing

This week’s FOMC decision was not an easy choice. Our goals are in conflict. Inflation is above target, the labor market is softening, and there are risks to both sides of our mandate—maximum employment and price stability.   Two charts explain why I ultimately favored a rate cut.   The first shows the damaging cost of high inflation. It has chipped away at real earnings and weakened household purchasing power. Many Americans are still trying to catch up.    So, the FOMC must continue to bring inflation down. Anything other than 2% is not an option. But it matters how you get there. This means we cannot let the labor market falter.   Real wage gains come from long and durable expansions. And the current expansion is still relatively young, as shown in the second chart. Holding policy too tight can cause undue harm to American families and leave them with two problems: above-target inflation and a weak labor market.   Congress gave us two goals. And our job is to meet both of them. The recent policy decision puts us in a good place to achieve that.

As expected, the Fed cut rates by 25 basis points and announced an end to quantitative tightening—both steps toward further easing. However, the meeting revealed some notable divisions within the Federal Open Market Committee. One member voted against the rate cut, while another favored a larger, 50 basis point cut. This dissent was a bit unexpected. Chair Powell also highlighted strong differences of opinion about a potential December rate cut and discussed the “neutral rate”—the level at which the Fed is neither stimulating nor restraining the economy. Powell suggested a range between 3 and 4%, higher than the 3% median estimate from FOMC members. These factors led markets to pause and reassess the likelihood and pace of future rate cuts. While markets still anticipate a December cut, the path ahead may be shallower than previously expected. Both stock and bond markets reacted with caution. For investors, this complexity is a sign that the Fed is weighing risks carefully—balancing the dangers of being too easy or too tough in today’s environment.  

As illustrated by this Bloomberg chart, the price shock emanating from the Middle East War has shifted market expectations toward a "higher-for-longer" rate environment across nearly all systemically important central banks. (The outlier remains the Bank of Japan, which continues to inhabit its own paradigm—though less so recently. However, identifying the changed rate trajectory is merely the opening act of the analysis.) The current situation represents more than a simple price shock; it also involves a "second-round" adverse demand shock. Beyond these immediate economic effects, there is the lingering risk of spillovers into financial instability. All of this underscores the uncertain outlook: central banks will be navigating a series of judgments which, I suspect, will likely (or should) be adjudicated by a single, sobering question: "Which is the least unrecoverable mistake we can make?" The answer to this question is less complicated for single mandate central banks, such as the BoE and ECB, than it is for the dual-mandate Fed. #economy #markets #centralbanks

We asked 25,000 Americans what they think happens when the Fed raises rates. Two-thirds said inflation goes up. In a new paper with Francesco Grigoli, Damiano Sandri, and Yuriy Gorodnichenko, we use randomized information experiments to trace how households' beliefs about monetary policy translate into their own spending and portfolio decisions. In households' minds, tighter policy still reduces consumption. But not through real interest rates or income, which is what most models assume. It works because households expect rate hikes to raise their cost of living, and they pull back spending to build a buffer. As the figure below shows, this expected inflation channel is bigger than borrowing rates, savings rates, wages, and unemployment combined. This is a partial-equilibrium story about how households perceive monetary policy and respond accordingly, not the full GE effect. But the striking finding is that inflation expectations appear to be a key driver of how households respond to monetary policy changes. Post on Empirical Macroeconomics Policy Center of Texas (EMPCT) is here: https://lnkd.in/eZp3ey4j

The Federal Reserve matched our expectations and reduced its policy rate by 50 basis points to a range of 4.75 to 5.00 percent. This was the right decision and demonstrates the Fed wants to get on-sides as the balance of risks shift. Turning to the next few months, here is what I believe is important. Powell is in control of the FOMC. He mentioned the core PCE nowcast during the blackout was a factor behind yesterday’s move and likely dragged a few of his colleagues (Barkin) across the 50bp finish line. The outcome of this meeting tells me that Powell’s threshold to do more is probably somewhat lower than his colleagues. This is one reason I am inclined to not put too much stock in what the dots show. Unemployment up to 4.4% likely implies some weak jobs and activity data between now and year-end. Powell won’t have it. The next fight will be picking up the pace to neutral. Another 50bp rate cut is a call option on the data deteriorating. A weak(ish) employment report, we get two between now and the next meeting, likely cements another 50bp rate cut. So, my baseline through year-end is another 75bps of cuts. Additionally, if inflation continues to run below two percent, which is a notable possibility over the remainder of year, I think it warrants a more rapid pacing of easing, irrespective of whether the activity data are slowing. All in all, I thought it was the right decision for the economy and my general sense is that if Powell does the right thing once, he is willing to do the right thing again. That’s good for markets and the economy. 

So, the Fed cut as expected and four things caught our eye: First, perhaps the more important story is how divided the policy debate has become. The new dot plot now shows three FOMC members projecting a rate hike in 2026, whereas the prior dot plot had every member expecting at least one additional cut over that horizon. Our view remains that more cuts and more balance sheet growth lie ahead, though we think that 2026 will be a more modest year of Fed easing.   Second, the Fed appears increasingly focused on the labor market rather than inflation. Chair Powell emphasized that much of the remaining above-target inflation reflects one-time tariff effects, not an overheating economy. We agree, though we believe that more goods inflation is on the way (goods inflation is actually only running 1.5% year-over-year), versus the plateauing in goods inflation that was signaled. Third, the Fed’s growth outlook has turned more constructive in a way that is very consistent with our long-held view: the incremental uplift to GDP is expected to come from productivity gains, not outsized job creation. As Chair Powell noted, if productivity runs closer to 2% per year, it has important implications for both real wages (which can be stronger) and unemployment (which can be higher) at the same time. We think this recognition is critical — and something many investors, particularly bearish ones, have underappreciated this cycle. Chair Powell also made clear that productivity is not just about AI; it is about automation, digitalization, and process redesign more broadly. We fully agree and actually only assign less than 20% of the productivity gains so far to AI. Finally, the Fed’s balance sheet is expanding again, with monthly purchases running at roughly $40 billion. In our view, this should be read as a signal that the Fed is pre-committing to ample liquidity and financial stability as it navigates this late-cycle environment.    Against this backdrop, we see today’s announcement as constructive for risk assets. Looking out to 2026, we continue to expect a steeper yield curve and a flatter spread curve, a combination that makes upgrading quality within Credit less costly than in recent periods. We also believe this environment continues to favor several of our key themes, including the Security of Everything, Productivity, and Worker Retraining, and the ongoing transition from Capital Heavy to Capital Light business models. Read more in our Outlook for 2026 being published next Wednesday.

Spending Falls, Inflation Rises: "Smells Like Stagflation Spirit" May’s spending, income and inflation data from the Bureau of Economic Analysis offered the clearest signs yet of tariffs weighing on the U.S. economy. Consumer spending declined noticeably, following months of front-loaded purchases ahead of expected tariff hikes. Even as demand cooled, inflation continued to edge higher—an early signal of stagflation, the combination of slowing growth and rising prices typically triggered by a supply shock. While inflation has remained within a tolerable range over the past three months, we don’t believe the full effects of tariffs have yet played out. Many businesses have so far absorbed higher input costs by leaning on inventories rather than passing them along to consumers. That buffer may soon erode. We expect increased price volatility over the next three to six months as firms begin restocking at higher, tariff-inflated prices. The Federal Reserve has signaled the possibility of one or two rate cuts this year. But more data will be needed to determine whether inflation pressures are truly under control—or just delayed.

Consumer Credit Crossroads: Spending, Saving, or Sitting Out? One year ago, Consumer Products bonds in the US HY Index traded 38bps (OAS) TIGHTER than the US HY Yield Master Index. The Consumer Products sector now trades 132bps WIDER vs. the index (note: both maintain the same B1 rating) or +160bps deterioration in spreads vs. the index. Investors and traders banking on the almighty consumer are feeling the pinch—ouch! The 90-day tariff pause has provided relief to this sector over the past 2 trading days. What comes next is critical. When spreads were tight over the past months, there was little dispersion. Dispersion is critical to judge, as there will be a growing delta between the winners vs. losers over the course of 2025—this will be critically important for investment performance. The elasticity of demand will differentiate the winners vs. losers since increased tariff costs will either be passed through to consumers, or NOT; the result will be important part of the formula that determines operating margins/profits. Wider spreads will present a buying opportunity of select issuers that have a strong moat and essential product selection—however, issuers with non-essential products, narrower margins and more susceptible supply chains will find a more challenging path ahead. In other words, these are the days when your credit investment manager is worth their weight (management fee). Consumer Products high-yield (HY) companies weakened as consumer sentiment declined and inflationary expectations rose; tariffs serve as the equivalent of corporate tax increase. Consumers now expect everyday essentials to become more expensive, leaving less room for discretionary spending, while tightening consumer credit and high financing costs provide limited access to finance big-ticket purchases. The net effect reduces demand for non-essential products. These factors collectively create a challenging environment for some HY companies reliant on robust consumer spending. With credit card APRs at record highs (around 20-25%), delinquency rates are rising for prime and non-prime customers. Consumer product companies will look to cut costs, solidify their supply chains that allow them to remain competitive (i.e., renegotiate supplier contracts) and/or localize production to offset tariff/inflation pressures. Notable names in this sector with meaningful China exposure include Newell Rubbermaid with ~15%, Spectrum Brands with ~45%, and Scott’s with up to 10% of their COGS, respectively. Late yesterday, Moody’s downgraded Newell Rubbermaid one notch (now Ba3 /Negative Watch) noting the company's ability to implement pricing actions to improve margins will be limited given the discretionary nature of most of its products and weaker consumer demand. During times of stress: up in quality, is my recommendation. As dispersion separates winners from losers, credit selection will be critical to performance as correlations remain wide.