Harvesting Opportunities: Income Diversification for Uncertain Times

Key takeaways:

  • The Fed continues to hold interest rates steady as it focuses on the totality of economic data before it begins to cut rates. Meanwhile, the markets now expect the Fed to cut rates only once toward the latter part of this year.
  • Corporate bond spreads have tightened as the probability of a US recession has declined compared to a year ago.
  • As the Fed eventually lowers interest rates, we believe corporate bonds, especially investment grade, could offer opportunities for both income and total return.
  • While the broader equity market has been somewhat resilient, it has been fairly range-bound as many companies in different sectors have failed to meet earnings expectations.
  • In our analysis, there are interesting opportunities in equities as the market overreacts to the short-term disappointments of high-quality companies we believe have longer-term potential.

Evolving inflation and interest-rate expectations

Looking back at these past six months, hotter-than-expected inflation data has shifted market expectations for interest-rate cuts in 2024. Going into the most recent Federal Open Market Committee Meeting (FOMC) meeting, some market participants were actually concerned we might see a hawkish Federal Reserve (Fed) and some talk of fed funds rate hikes coming. However, Fed Chairman Jerome Powell put these worries to rest and stressed that policymakers are looking at the totality of data and not just pieces of economic data that might not be pointing in the same direction.

In our opinion, the Fed’s March summary of economic projections, as shown in Exhibit 1, is about as good as it gets. The Fed expects gross domestic product (GDP) growth to remain resilient and maintain a level above longer-term expectations. Similarly, Fed policymakers do not foresee unemployment rising materially over the next several years despite the tightening they put in place. In our opinion, with initial jobless claims increasing to the highest level in quite some time, comprehensive labor market surveys may be overstating job growth. Thus, the labor market will be a key focal point for us in the near term.