Making Sense: September Q&A

Amy: Hi, I'm Amy Thomas, a strategist here at First Citizens Bank. Today is September 11th, 2024. I'm joined by our Chief Investment Officer, Brent Ciliano, and Director of Market and Economic Research, Phil Neuhart, to answer some of the questions we're hearing most often from clients.

By the way, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. None of the information you hear today should be considered as tax or legal advice.

Phil, Brent, we got fresh inflation data this week—a little bit of a surprise here and there. Can you react to that, please?

Phil: Yeah. So headline inflation now year on year is running at 2.5%. Just to put in context how far we've come, that's the first time we've had 2.5% inflation since the first quarter of 2021, which is really, really incredible.

Brent: Yeah, significant progress.

Phil: The surprise came in core inflation. And core inflation as a reminder excludes the impact of food and energy. And we saw month-on-month core inflation come in at 0.3%, which pushed the year on year to 3.2%. That 0.3% was rounded to 0.3%. It was in the high-twos, but still was a little bit above expectations.

We did see the 2-year Treasury yield, at least initially, move higher in reaction to that. The idea that rates might be a little bit higher than thought before the CPI report.

Brent: And a lot of that impact came from the shelter component, owner and equivalent rent. Again, you know, in that .28 number that we saw, right, much of that was driven by that hot number, right? So, again, without owner's equivalent rent coming in hot, we would have been closer to a zero number for the month. So a lot of volatility in the dataset for sure.

Phil: Yeah, shelter inflation's just remained really stubborn, and we've had really tight inventory in the housing market. That started to improve, but when rates fall—which we have seen in mortgage rates—that brings demand in as well. So shelter inflation's very difficult for the Fed to control.

As we look ahead to next week, I think that this number certainly makes the probability of a 0.25% fed funds cut more likely than the 0.5% or 50-basis-point cut because this number came in a little bit hotter than expected. We did see, at least initially, fed funds futures move that way. But policy is still pretty restrictive. Right, Brent?

Brent: Yeah, I mean, certainly, I mean, like you were saying with a core CPI number of 3.2%, core PC at 2.5% and fed funds still up between 5.25 and 5.5%—we are still incredibly restrictive. So from that standpoint alone, from a normalization, you wouldn't say "Hey, 50 basis points makes sense because the Fed is undoubtedly behind the curve," but we'll see what the data looks like next week. We just have to wait and see.

Phil: It's absolutely time for the Fed to act, and markets are moving in that way based on all these data points.

Brent: Absolutely.

Amy: And sticking with the Fed, what does that mean for the future of rate cuts going into the rest of this year and into 2025?

Phil: Yeah, I think that clearly the Fed is cutting in September—probably a quarter-point. Pretty clearly they're going to cut in the next two meetings as well. There's three meetings left for this year. Probably a quarter point, but certainly depending on data, 50 basis points is probable. We're going to have at least three cuts this year. I think that that's pretty set. The real debate is around next year.

Brent: Yep.

Phil: Futures are pricing as something like nine, ten potential cuts between now and the end of next year. When I say nine or ten cuts, I mean 0.25% cuts to be clear.

If that were to happen, it probably means something broke in the economy. We tend to be in the camp that maybe the Fed—yes, they're playing a little bit of catch up, cutting in the fourth quarter, in September of this year—but then as we move into next year, maybe they're a little bit more measured than cutting every meeting, for example.

Brent: Yeah. And if you look at sort of, let's just say, the more liquid markets. Let's take a look at the 2-year note, right? The 2-year note is roughly about 175 basis points below where fed funds are, which is—would price in something less than ten cuts. More like, you know, seven-ish cuts, not ten cuts. So again, it's more of a, you know, a callout that we're going to see a lot of variability in market expectations for where the Fed actually ends up.

But by and large, look, what's undoubtedly going to happen is the Fed, we believe, will start next week. The path between now and the end of the year might be a little bit more certain than the path between now and the end of 2025, and we're just going to have to see. But the start of a Fed cutting cycle, we believe, is undoubtedly underway.

Amy: And, Brent, speaking of a 2-year note, what does this mean for fixed income? I know you've been involved in a lot of client conversations. What are you saying to clients today?

Brent: Yeah, so let's talk about it. And certainly one of the reasons why we're getting lot of the questions is that from the highs that we saw back in April, yields are starting to move. As we're talking about right now, the Fed is going to start tightening their policy, right, and start getting to a point where we start seeing—

Phil: Reducing the overnight rate.

Brent: Reducing the overnight rates. Start cutting. And that basically means we're seeing a lot of volatility in rates. So clients are asking, you know, where does positioning, what makes sense? And certainly, I think, first of all, number one, yields are still very attractive. Even though yields are falling relative to where we were 3 and 4 years ago, you're still getting some yield. In ag bond, you're still north of 4%, muni is still north of 3%. So you're still getting yield there.

By and large, we actually believe that where you're seeing most of the volatility is inside of 10 years. We're going to continue to see rates inside of ten move lower, but with a lot of volatility. We move significantly lower kind of in that, you know, sort of 6-months-to-3-years bucket, and that's sort of affecting people's views on "Where do I actually sit as it relates to Treasuries and enrolling short-duration fixed income." We think corporate bonds are starting to look attractive from a relative-spread perspective, relative to Treasuries.

We've seen the sort of spread in corporate bonds contract less than what's going on in the Treasury movement. So a lot of volatility there. We think overall, make sure that you stick with your financial goals and objectives and make sure you stick to that plan or your investment policy statement if you're an institutional investor.

Phil: Yeah, when you think about the shape of the yield curve, we've had this incredibly inverted yield curve for so long, and it uninverted a little bit over the last week—at least the 2-year, 10-year—but so much has been priced in further out in the curve. You're seeing those big moves down that just because the Fed is cutting does not mean it impacts those longer-term yields as much. It's really going to be the short-term yields that are going to be playing catchup.

As you mentioned, I think clients need to think about and remember that the Fed controls the overnight rate. They do not control, say, the 10-year Treasury or the mortgage rate. That's why those rates have already moved down—mortgage rate being a great example—before the Fed has begun to cut.

Brent: Absolutely. And, Amy, the question that we're getting a lot from clients is "Is it too late to get into fixed income or if I have to potentially reposition our portfolio for whatever from a financial planning perspective?" And the answer is unequivocally no, right? The yields are still fundamentally attractive, but what you should expect is volatility.

But by and large, again, where we see much of that volatility is kind of on that shorter end of the curve. Like we talked about anywhere between sort of that 4-week note all the way out to 3 years is where you're going to get a lot of that price movement and price action, which again is going to, in our opinion, say that you probably want to focus on professional money management as it relates to where you need to position and how you need to think about your money. But, again, definitely not too late and still attractive from an intermediate to longer-term perspective.

Amy: Well, Brent, Phil, thank you both so much for your time today. We hope you found this information helpful. For more information, please visit FirstCitizens.com/Wealth.

Making Sense

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Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Brent.Ciliano@FirstCitizens.com | 919-716-2650

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Phillip.Neuhart@FirstCitizens.com | 919-716-2403

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