Our Chief Fixed Income Strategist explains why the Federal
Reserve’s most recent meeting was so consequential, and the
likeliest path ahead for interest rates.
----- Transcript -----
Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan
Stanley’s Chief Fixed Income Strategist. Along with my colleagues
bringing you a variety of perspectives, I'll be talking about
last week’s FOMC meeting and its impact on fixed income
markets.
It's Thursday, May 9th at 1pm in New York.
Last week’s Fed meeting was consequential. It had a clear and
unambiguous messaging about the path ahead for Fed’s monetary
policy. Fed’s next move in policy rate is unlikely to be a hike.
The Fed’s focus now is on how long the current target range for
the fed funds rate will be maintained; and the next move,
whenever it happens, is likely a cut. Importantly, the FOMC’s
decision was unanimous and their statement maintained an overall
easing bias.
In the aftermath of recent upside surprises to inflation and the
reaction in the rates market, many market participants, yours
truly included, were apprehensive that the FOMC’s tone might be
overtly hawkish. Turns out, that was not the case. By setting a
very high bar for the next move to be a hike, the Fed’s message
has meaningfully narrowed the distribution of outcomes for policy
rates, at least in 2024 As our economists led by Ellen Zentner
note, the two likely policy outcomes now are keeping the rates on
hold or cutting.
Given the prospect that policy rates may remain in the current
target range, the negative carry of an inverted yield curve keeps
us from pounding the table to move to outright long in duration,
although the direction of travel does suggest that. We would note
that Guneet Dhingra, our head of US interest rate strategy, sees
better risk/reward in duration longs through 3 month 10 year
receivers than in the very crowded curve steepener trade. In
general, spread products in fixed income – agency MBS, corporate
credit and securitized credit – stand to benefit the most from
this notably less hawkish messaging, in our view.
As Jay Bacow, our head of agency MBS strategy, observes, the
backdrop in which tail risks of higher policy rates are much more
remote than they were before the FOMC meeting is supportive for
agency MBS. At current valuations, agency MBS offers an
attractive expression for investors seeking to play for lower
interest rates, lower interest rate volatility or both.
Their high all-in yields have bolstered strong inflows and
sustained demand for corporate credit across a wide range of
investor types. If policy rates remain in the current range, we
expect the demand for corporate credit to accelerate. If policy
rates stay in the current range or go lower, pressures on
interest coverage are unlikely to get worse going forward. Given
their high single-digit all-in yields, we see an attractive
risk/reward calculus favoring leveraged loans. We like expressing
this view directly in loans as well as in securitized credit
through CLO tranches.
In sum, the message from the Fed was clear and unambiguous. The
policy rate path ahead is for rates to remain in the current
range or decline, and the bar for the next move to be a hike is
very high. This bodes well for a wide range of instruments in
fixed income.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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