Macro

The FED evaluates the optimal inflation rate and the policy path to achieve it. It is trying to prioritize the labour market over the noisy inflation data, as it didn’t change its December projections and committed to 3 rate cuts over the remaining 6 meetings this year. This is despite its now forecast of more inflation this year and next year and more growth this year and next year. The Fed is also planning to keep pace with QT.

Growth in jobs in the US is quite concentrated around the public sector, but given the budget deficit, this is unlikely to be sustainable in the long term. The JOLTS Private Quits Rate is declining, which suggests decreasing wage pressure. In Europe, the unemployment rates are pretty low, which keeps pushing wages higher, but with the beginning of the economic slowdown, wage growth is expected to slow. Indeed, the wage Tracker indicates that wage growth is already slowing.

Revised growth was higher, revised unemployment was lower, and core inflation was increased but left the dot-plot unchanged. Those strong numbers point to more persistent inflation, and the fact that the Fed keeps its cut plan reflects that it is worrying more about recession than hitting the target inflation rate.

As the economy is more resilient than expected and inflation is more sticky than expected, the market has adjusted its rate expectations to 3 rate cuts. This aligns with the FED’s dot plot from December and now (as explained in the macro section above) with the FED’s current plan.

Rate

A few months ago, everyone wondered about the liquidity in the Treasury market, given the massive increase in supply and decline in demand from international buyers. Today, there is less concern about demand as individual investors step up. Nominal rates of around 5% and real rates of over 2% are attractive for households who gain exposure either directly or through short-term money market products.

After the FOMC, the belly of the curve is still most attractive. If the expected terminal rate is 3.75% but the FED neutral is 2.5%, the mid-term bonds will be most sensitive to FED cuts. Furthermore, $6t sitting in money market funds and yields on those instruments are under pressure as the FED is still expected to start cutting in June.

Expectations for interest rates drive the majority of moves in yields. If one believes that rates will decline faster than the market anticipates, that would give a positive outlook on bonds. For investors with this outlook, there are many bonds with significant discounts to choose from. For example, the drawdown for long-term bond investors is still massive, currently at around -46% for the 30Y treasury holders, despite a significant decline in rates since their peak in October 2023.

A small minority of investors believe that the FED should increase rates further, citing the increased appetite for risk and exuberant valuation as reasons. However, it is not a FED policy to interfere with the rising prices of financial assets or influence investors’ risk appetite. The only exception was the GFC because the bubble was in real estate rather than financial assets, which prolonged it for much longer.

Credit

The US IG issuance is booming, with year-to-date sales passing $500 billion, the fastest start to a year on record. This month’s high yield was also red hot, with this month already becoming the second business in March of the last five years. Total HY issuance year-to-date was $15.5b.

US HY and IG options adjusted spreads are at their lowest since the pandemic; they are also approaching lows before the GFC. How long credit spreads might stay low, given that they are close to historic lows. Bankruptcies are rising, but spreads are tightening, which is an unusual pattern.

Investment grade investors consider the fact that rates are expected to get lower more than the fact that they spread. From the balance of risk, there is more catalyst for potential widening of spreads. Risk reward gets even less, appearing down on the quality spectrum.

Equities

The dovish tone on FOMC pushed indexes to an all-time high, with S&P reaching 5,200 points. The FED’s conference shed light on equities and may trigger a broadening of participation. The S&P is currently trading at 34 CAPE (Cyclically Adjusted Price-to-Earnings) multiple, which is the 96th percentile of the long historical average. However, bullish equity investors believe there is much more room to run. 260$ earnings per share and optimistic 25 forward earnings give 6,500 on the S&P 500.

Optimism comes from the tale of a significant boost in productivity driven by AI, but this has yet to materialize. Such a productivity increase would put downward pressure on inflation and indirectly on interest rates. This will then positively affect long-duration assets, including tech stocks.

AI is generally a transformative technology that will improve economic growth through major productivity gains, but it will take some time, even years, for those changes to defuse the economy. However, investors are trying to capture those future benefits now, frontloading the gains until today, leading to a rapid acceleration in the prices of related equities.