FEBRUARY 11, 2024
The Federal Reserve’s pushback on expectations for interest-rate cuts over the past two weeks has investors closing watching inflation data and piling more cash into money-market funds.
Investors stashed a record $6.48 trillion away in U.S. money-market funds through the end of January, with the balance growing as euphoria in December over a Fed policy pivot fizzled, according to Crane Data.
Fed Chairman Jerome Powell first poured cold water on aggressive expectations for rate cuts at a late January policy meeting by indicating a March rate cut wasn’t likely. He followed up days later with a CBS News “60 Minutes” interview, telling 6.6 million viewers that the central bank would tread carefully on rate cuts because inflation isn’t yet convincingly tamed.
“He really put a big damper on it,” said Deborah Cunningham, chief investment officer, global liquidity markets at Federated Hermes, a group that had $560 billion in money-market assets as of Dec. 31. “The market got ahead of itself in November and December.”
Cautious bonds
Earlier optimism about lower interest rates, potentially as soon as March, helped U.S. bond funds swing to positive returns in 2023.
Yet, many benchmark bond indexes were back in the red in February, with the 10-year Treasury yield climbing to 4.186% on Friday, the highest since mid-December.
“The equity market wouldn’t notice, but the bond market is certainly listening to Powell,” said George Catrambone, head of fixed income at DWS Group, in a phone interview.
“Powell took away the punch bowl in January, but that was needed,” he said. “They do need to guard against a reacceleration of inflation.”
With that backdrop, Catrambone called next Tuesday’s scheduled release of the consumer-price index for January the week’s “main event,” particularly after a strong January jobs report and data showing a the U.S. economy grew 3.3% in the fourth quarter.
A seasonally-adjusted CPI for the fourth quarter came in Friday at a 3.3% annual rate, underscoring the progress the Fed has made in bringing price pressures down from a more than 9% peak in this cycle. Still, the cost of living remains above the central bank’s 2% target.
“I do think the Fed is pleased with the inflation progress thus far, but we need to see more,” Catrambone said. With that backdrop, he remains an advocate of investing in the front-end of the Treasury yield curve, particularly with rates on 6-month Treasury bills above 5% for nearly a year.
“While the bar to cut is high, the bar to raise is even higher,” Catrambone said.
S&P 500’s milestone
Cautious tones in the bond market in recent weeks have been largely missing from U.S. stocks, with the Dow Jones Industrial Average and S&P 500 index both embarking on a record-setting spree to start 2024, and the Nasdaq Composite Index not far behind.
Adam Hetts, global head of multiasset at Janus Henderson Investors, said that staying in cash can be tempting, especially last year when recession concerns had been at the forefront for so long.
“Investors are now expecting a Goldilocks scenario,” Hetts said, a situation where the economy keeps growing but inflation continues to fall. Along the way, they likely need to stomach “hot and cold economic news.”
“Investors too focused on the recession crystal ball went into cash, enticed by high rates,” Hetts said. But by avoiding stocks, investors would have missed out on the S&P 500’s roughly 23% advance in the past 12 months, according to FactSet data.
“Cash is king for short-term liquidity needs, but being overweight cash can be toxic for long-term financial planning,” Hetts said.
To that end, he favors a more traditional 60:40 allocation to stocks and bonds, especially given the higher yields available in intermediate-duration fixed income to offset any turmoil that could erupt in equities that look “priced to perfection.”
The S&P 500 on Friday closed above the 5,000 mark for the first time ever, while gaining 1.4% for the week to close at a record 5,0526.61, according to Dow Jones Market Data.
The Dow advanced less than 0.1% for the week, ending at 38,671.69, while the Nasdaq rose 2.3% for the week, finishing at 15,990.66, only 0.4% off its previous record from November 2021, according to Dow Jones Market Data.
Meanwhile, cash parked in money-market funds has been earning about 5% for many months, helped along by the yield on the 1-month Treasury bill and 3-month around 5.38% as of Friday, according to FactSet.
With the new “realty check” in markets around rate-cut expectations this year, Cunningham at Federated Hermes said getting to a $7 trillion balance for money-market funds isn’t hard to imagine.
Courtesy: Marketwatch
