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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
The Fed has spoken.
A 50 basis point rate cut.
But the vote was not unanimous.
Now we ask, what does this mean for the fixed income
markets and how should investors position their portfolios?
Welcome to the TCW Investment Perspectives podcast focused on fixed income.
I'm Anisha Goodly in Los Angeles and I'm joined by Generalist
Portfolio Manager Jerry Cudzil, Global Rates Co-Head
Jamie Patton, and Global Credit Co-Head Brian Gelfand.
Today, we're going to hear the team's initial reaction to the
start of the easing cycle and what they're watching for ahead.
Thanks everyone for being here today.
Thank you.
Well, Jerry, I'd like to kick off with you.
So, as we know, there's been a considerable amount
of debate around the size of today's rate cut.
What's your initial take on the outcome?
Well, I think our initial take is, you know, the old
saying that, you know, first cut is the hardest.
I think as we think about what the Fed did, the Fed cut 50 basis points.
They saw the data that we've been speaking to,
which is a slowdown and easing of the labor market.
And Powell had talked to the balance of the slowdown in the labor market,
the slowing down of the economy, and the trajectory of inflation.
And that gave the Fed the ability to move at 50 basis points.
Market clearly has 125 priced in by the end of the year, in our
opinion, and clearly we're not stating anything profound here.
There's only one way to get there, and that's to take a multi-step cut.
I think what is interesting, though, is to take a step back and say, it wasn't,
you know, three months ago where the Fed has said, "We're gonna do one cut
by the end of the year." And now what they've done is they've said, "We're
gonna have four cuts by the end of the year." That's three months later.
They've reversed course in a pretty significant way.
All of the members, even the dissenter has agreed that
there will be multiple cuts by the end of the year.
And I think this is the point.
This is the main point.
Whether it was 25 or whether it was 50, the point is the Fed got started,
the economy is slowing down, the labor market's slowing down in a
material way, and the Fed is and remains significantly data dependent.
So our view, as we take a step back and say, "Okay, what does
all this mean for fixed income?" Our view is that the Fed
is gonna continue to have to go in a more aggressive way.
We remain convicted in the bull steepener.
We remain convicted that the Fed will need to
go faster than what's priced into the market.
- Well, thanks, Jerry.
Jamie, I'd like to pick up with you on that
point that the Fed has to be more aggressive.
So I know it's only been a few hours, but
what is the rates market telling you now?
And where do you think we're differentiated there?
- What the rates market's telling us, what the dot plot is telling us,
and what we think is actual reality are three very different things.
So the rates market is telling us that we're
going to have this perfect soft landing.
You could even argue that it might be pricing in a no landing,
just because we never really have rates get back down below
the Fed's own definition of neutral in the forward curve.
The rates market has this amazing fairy tale of a story.
The dot plot is showing a very divided committee.
So there was only one official dissent today, but if you look
at the breakdown of the dots, there are two dots that say,
we're not even going to need another cut this whole year.
If you think those people really wanted 50 basis points, I don't know.
It's hard for me to imagine.
It seems like they went along with their boss.
And then there's another seven people that think there's
only going to be a need for one more 25 basis point cut.
So that's almost half of the committee thinks that we
barely even have to cut any more for the rest of the year.
Similarly, the long-term dot, and we define
this as the Fed's own idea of neutral.
It's so dispersed.
You don't have more than three dots on any one rate, and
it ranges from two and three A's all the way up to 375.
So the way we think about this is imagine that you're on an airplane,
you have 19 pilots, and they all completely disagree about the
elevation of the airport when you're coming in for a landing.
It's really hard to imagine that's going to go well.
So where we think there's a huge opportunity is long duration, especially
in the front end, the two to five year sector, that's most sensitive to
Fed policy rates because not enough is priced in and it looks like
we're going to have a bumpy landing wherever that landing may be.
Well, I want to take that last point and pivot over to you, Brian.
So thinking about that, you know, we talk about spreads
and maybe there's some fairy tales priced into spreads.
What are the credit markets telling you?
Yeah, no.
And speaking of, you know, inconsistencies, if our view and the Fed sharing that
view is cutting 50 basis points because they believe we're seeing a slowing
in the economy, credit spreads are definitively
pricing in the soft landing narrative, right?
IG credit spreads, 89 basis points over treasuries, high yield and in the
low 300s, not pricing in prospective volatility, prospective principal loss.
What happened today though, is not consensus shifting necessarily.
So I think the credit markets will weigh what took place
today over the coming quarters, over the coming months.
As we see labor market data come through, as we
see earnings, corporate earnings come through.
What's interesting and what we're watching is the most recent quarterly earnings
from the companies we speak with, particularly those that face the consumer.
Everyone knows that the low income consumer is struggling right
now, but the narrative that's taking place in Q2, seemingly
from management teams is that there's this bleed up effect.
Now middle income consumers are starting to ration.
And so that's a new effect.
And we'll, we'll see if that continues, you know, going forward.
Either way, our view is that credit spreads don't price in that
slowing economy and that asymmetric path forward for spread
widening versus tightening leads us to be cautious, i.e.
high grade portfolios focus on companies with solid balance
sheets, good cash flows, less pro cyclical business drivers.
Thanks.
Thanks, Brian.
And I'd like to turn it back to you, Jerry, to close it out.
Given that view on the rate side, on the credit side, can you share
with us again how you're thinking about portfolio positioning and
how clients should think about fixed income in their portfolios?
Sure.
I think when we think about the markets and the outlook, I think it's clear
that the Fed has shown their ability, their desire to remain data dependent.
And I think, I think that's the key.
The key is the Fed is as data dependent as they've ever been at a time when
maybe the quality of the data is as questionable, maybe as it's, as it's been.
And when we look at the data and when we look at whether it's micro or
macro, we're seeing a real continued loosening of the labor market.
And we think that's going to continue to seep through.
Positioning remains the same.
We remain convicted in the portfolio positioning, which is asymmetry
in credit spreads means that we remain underway corporate credit.
The payout profile in corporate credit from
our standpoint looks relatively unattractive.
We continue to like agency mortgages as we think the normalization
of rates and the continued move lower in rates and the steepening of
the curve will benefit agency mortgages and non-agency mortgages.
And then to Jamie's point, to round it out, the duration positioning, we remain
constructive on duration, especially in the front and belly of the curve
and how will, you know, kind of bonds fit into portfolios to sum it up.
Bonds can be bonds again, you know, bonds will, will perform at a time when
economy slows, stock market potentially has some volatility, risk assets
have some volatility and your bonds will be
the ballast that they've been in the past.
Thanks everyone for your insights today.
That's it for this edition of TCW Investment Perspectives focus on fixed income.
I'm Anisha Goodly, and I want to thank our guests,
Jerry Cudzil, Jamie Patton and Brian Gelfand.
Join us for more expert analysis and in-depth
conversations on the trends shaping financial markets.
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