Total Return Outlook: It’s Like Déjà Vu All Over Again

In titling this quarter’s outlook, it was a close call between Yogi Berra’s famous déjà vu quote and that of French writer Jean-Baptiste Alphonse Karr, “plus ça change, plus c'est la même chose” – which translates to “the more things change, the more they stay the same.” Although the Fed remains singularly focused on controlling inflation, as evidenced by the recent 75 basis point increase in the fed funds rate, we have yet to observe a meaningful drop in inflation. Not surprisingly, fixed income markets remained under pressure, delivering another quarter of negative returns characterized by spread widening and interest rate volatility.

Despite the acceleration of the Fed’s response, price increases persisted throughout the economy last quarter, as indicated by most every inflation metric, whether CPI, PCE (the Fed’s favorite), UIG (our favorite), or any of the others found in the alphabet soup. We look at UIG as an indicator of persistent inflation – in that sense, it has more value than the others, which tend to include price shocks from temporary disruptions. Further, Fed policy should be calibrated to bring UIG lower, and in our minds when we consider the Fed’s target of 2%, it is the persistent level of inflation that matters most.

Regardless of measure, we are nowhere near realizing this ideal. Markets recently have relished weakness in manufacturing and housing, interpreting both as signs that the economy is slowing, which should decrease inflationary pressures and allow the Fed to slow its pace. However, these headlines also suggest a recession looms, which helps Treasuries but hurts risk assets across the credit spectrum. And, just as quickly as you have a poor data point, a Fed speaker or pundit will reiterate the Fed’s commitment to squashing inflation – even in the face of economic weakness – taking the steam out of any Treasury rally.