September 17, 2024
Dear Investors and Friends,
As the Federal Reserve meets today, it is widely expected that, after 11 rate hikes between March 2022 and July 2023, we may be approaching a turning point. In his recent remarks at Jackson Hole, Fed Chair Powell stated, "[t]he time has come for policy to adjust," strongly suggesting that rate cuts may be announced at the conclusion of the Fed’s meeting tomorrow, September 18. In light of this, a question we are frequently asked is: Is it time to extend duration? Below, we explore what’s currently priced into the market, rate cuts in a historical context, the accuracy of rate predictions, potential movements along the yield curve when the Fed cuts, and how RCM is positioned.
What’s Priced into the Market?
The market has already priced in a significant reduction in rates over the next year. Below is the Fed Funds Implied Overnight Rates and the number of cuts projected by the market between now and early 2027. For example, by September 17, 2025, the implied rate is 2.87%, which suggests a decline of nearly 2.5% in the next 12 months. Critically, these implied rates represent the market's forecast for future Fed Funds rates. The “pricing in” of future expectations is an often overlooked variable when the press talks about interest rates. Put a different way, all other things being equal, because the market has already priced in rate cuts of nearly 2.5% over the next 12 months, anything less than that would actually lead to an increase in the yield of longer-dated Treasuries. Obviously, there are many variables beyond the Fed Funds rate at work that impact Treasury yields but the importance of these expectations cannot be overstated.
*As of 9/13/24
Rate Cuts in a Historical Context
While a 2.5% rate cut over the next year is certainly possible, it would be considered aggressive by most historical standards. Since 1970, there have been seven instances where the Fed cut rates by more than 2.5% in a single year. These include the 1973–1975 recession, the 1980–1982 Volcker recession, the 1990–1992 Savings and Loan crisis, the 2001 dot-com bubble, the 2008–2009 global financial crisis, and the 2020 pandemic (though the pandemic cuts didn’t quite reach 2.5%, they likely would have if rates weren’t already at artificially low levels due to the aftermath of the GFC). What all of these events have in common is a severe economic downturn; we do not see any signs in the economy that would lead us to believe we are on the precipice of not just a slowdown, but a major recession.
How Accurate Are Market Predictions?
It’s essential to consider how often these predictions miss the mark. Below, we’ve shown the implied rates from December 31, 2023. At that time, the market projected that the Fed Funds rate would be around 4.1% by now, yet today’s Effective Fed Funds Rate sits at 5.2%—a full 110 basis points higher than expected. This highlights the difficulty and uncertainty inherent in predicting rate movements, even in the short-term.
What Will Happen to the Shape of the Yield Curve as the Fed Cuts?
The chart below shows today’s Treasury Yield Curve. Simplistically, each point on the curve can be seen as the market’s expectation of the average Fed Funds rate over that period.
*As of 9/13/24
As the Fed begins to cut, the front end of the curve will come down. But what about medium- and longer-term rates? As mentioned earlier, if the 2.5% reduction in rates over the next year materializes, rates further out should remain largely unchanged. However, if the market senses that further cuts are coming, we could see medium- and long-term rates fall. Conversely, if the market anticipates fewer cuts, expect rates to rise.
How is RCM Positioned?
RCM does not take directional bets on interest rates, particularly in an environment where the front end of the curve is steeply inverted. If market conditions shift and present a compelling case to extend duration, we will certainly reevaluate our positioning. For now, however, we view the current front-end yields as an opportunity—offering higher returns, lower interest rate risk, and greater flexibility.
While we agree that rates will come down in the near term, we are skeptical of the speed and magnitude of those declines. Even if we’re wrong, remaining on the front end of the curve allows us maximum flexibility to react to unforeseen developments—an essential element in effective risk management. Plus, we’re earning the highest yields available to do so.
Please don't hesitate to reach out with any questions or comments. Thank you for entrusting RCM with your capital; it's a privilege to serve you, and we look forward to continuing our work together in these ever-evolving markets.
Warm Regards,
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. The information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.