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CIO Strategy BulletinArticle04 May 2024

Interest Rates: What Will “Normal” Look Like?

CIO Strategy Bulletin

Where inflation and interest rates settle is a critical question for investors. In our view, the number of Fed rate cuts in the shrinking 2024 calendar is not where concerns should lie. History shows the lurch to judgement on US rates is often inaccurate and expectations unstable.

Key Takeaways

  • Fed Chairman Powell last week counseled for patience as the Fed’s preferred inflation measure continues to slow even while remaining above the long-term target of 2%. If US employment growth remains on a slowing trend, we see the Fed being able to reverse a portion of its large tightening steps of the past two years, with the first steps taken this year. If we are wrong and the Fed cuts rates later than we expect, the exact timing shouldn’t matter much for most asset prices. \
  • We believe the post-pandemic inflation surge jarred the world out of complacency about inflation risk. While the Fed has largely succeeded in shutting down any lasting rise in inflation expectations, there is greater risk premia in real bond yields. 
  • For the fixed income portion of an average investor’s asset allocation, we see the greatest value in high-grade intermediate-duration bonds. Across a range of bond segments, average yields are near 6.0% for 4-5 years. This is much higher than the Fed’s estimate of its “longer-run” normal policy rate (2.6%).

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