Outlook for US Fixed Income and Equities Amid Tighter Financial Conditions

Key takeaways:

  • Following the US Federal Reserve’s (Fed’s) series of aggressive interest-rate hikes, inflationary pressures have shown signs of easing. We believe this may pave the way for a “pivot to a pause” in monetary policy.
  • The impact of tightening financial conditions is uncertain as we go through 2023. We are mindful of risks given a potential economic slowdown, which can impact corporate earnings (fundamentals) and company valuations.
  • We will continue to favor fixed income, particularly investment-grade credit, if the asset class continues to offer what we consider attractive yields and total return potential.
  • We believe that a broad exposure to equities is important, particularly in companies that can prove that they are resilient and offer appreciation potential.

What’s driving the Fed’s policy and what does the path forward look like in your view?

Perks: The Fed’s pace of interest-rate hikes has become quite rapid relative to prior cycles in the last four decades. Prior to the increase of 25 bps on February 1, the Fed raised interest rates 425 bps in 2022. The markets seem to think that the Fed is very close to not only being done raising interest rates, but also at the point where in the second half of this year, and certainly into 2024, that there may be fairly significant cuts to interest rates. That’s one of the things that caused the markets to rally. However, we believe that it’s a little premature to start discounting interest-rate cuts, largely because the economy is still performing well despite decelerating growth and inflation. Fed Chairman Jerome Powell’s recurring message is that increases look to continue.

The Fed has done the hard work to rein in inflation. At this point, I think the path for monetary policy for the remainder of 2023 will be significantly more dependent upon economic data. It’s possible that the monetary policy tightening that we’ve seen so far will take six to nine months to take effect. So, we just have to evaluate the data as it comes.