The Road Ahead for Equities and Bonds
The October 2024 meeting of the Investment Committee was focused on several key macroeconomic trends and their potential impact on our investment strategy, particularly with respect to interest rate movements, US equity markets, and the broader financial landscape.
US Dollar and Interest Rate Outlook
Historically, the performance of the US Dollar (USD) around the beginning of an easing cycle has been mixed. Looking at seven Federal Reserve rate-cutting cycles since 1995, we observe no statistically significant pattern in the Dollar's behavior before or after the start of such cycles. This unpredictability makes it crucial to focus on interest rate movements rather than relying solely on currency trends.
The committee emphasized the critical role that US interest rate cuts will play in the months ahead. Currently, the 2-year US Dollar interest rate has dropped from 4.7% to 3.6%, creating a record inversion of the yield curve compared to the current Fed Funds benchmark rate.
Market Implications of Interest Rate Derivatives
Probabilities derived from interest-rate derivatives suggest a 50/50 chance of a 0.25% to 0.50% rate cut in the next Federal Reserve meeting. However, what stands out is the likelihood of US rates reaching 3% or lower by the summer of 2025. For US investors holding 2-year notes, the 1-year forward rate will need to fall from 3.8% to 2.95% for such an investment to be profitable.
Source: CME FedWatch
Equity Markets and Bond Yields
The implications of this forecast are twofold: if financial conditions necessitate such significant rate cuts, the current levels of US equities—at or near all-time highs—may be unsustainable. Historically, wide spreads between short- and long-term rates, as we see now, have often signaled economic trouble.
Thus, the committee identified a few potential outcomes:
Limited Downside for Interest Rates – If the Fed cuts rates further, bond prices may have little upside potential, which could limit future gains in fixed-income investments.
Increased Equity Volatility – Equity markets could experience more frequent and longer-lasting dips, given the anticipated repricing of benchmark rates and potentially overvalued stock prices.
Investment Strategy Recommendations
Given this analysis, the committee recommends maintaining a balanced approach across asset classes:
Equities: Expect increased volatility and potential corrections, with a focus on defensive sectors such as consumer staples, utilities, healthcare and high dividend.
Fixed Income: The limited upside for bonds suggests a cautious approach, favoring shorter-duration assets to mitigate risk from potential rate adjustments.
Diversification: We continue to advocate for exposure to multi-asset strategies, including alternative investments, to hedge against equity volatility and interest rate uncertainty.
Conclusion
In summary, while the path of interest rates remains the central factor driving market expectations, our diversified strategy, encompassing both systematic and discretionary management, positions us to navigate these uncertain times effectively.
Authors: John Couletsis and Kostas Metaxas