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Ignore the tantrums and focus on what matters

Ignore the tantrums and focus on what matters

Kids are regularly disappointed – often vocally – when they don’t receive what they want. When those kids become investors, the tantrums they throw can be seen in market reactions to their disappointments. And many investors, forecasters and commentators are predicting a tantrum amid changing expectations for rate cuts in 2024.

Earlier this year, I flagged the possibility that we may arrive at the end of the year and find interest rates precisely where they are today. That prediction didn’t prevent investors from becoming excited about the prospect of a series of rate cuts this year. It was always a long bow to draw. 

Humans are terrible at predicting turning points. We believe that the recent past provides the template for what to expect in the future. After a period of rapidly rising interest rates, it’s reasonable to expect rate volatility to continue. It’s, therefore, not unusual to discover investors expect a sharp reduction in rates as soon as inflation approaches its central bank-defined target rate. 

The harder thing to predict is the once-rapid changes in rates will stop changing rapidly and enter a period of stability. And so, remembering Mark Twain’s admonition – “Whenever you find yourself on the side of the majority, it is time to pause and reflect” – I thought there is every chance rates do little this year if they do anything at all

So now we find ourselves in a position of anticipating the market’s anticipated disappointment. That reminds me of Ben Graham’s observation; “We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be.”

I should say, however, there is a silver lining to all of this, which I mention towards the end of this post.

The debate about the U.S. Federal Reserve (Fed) is shifting from arguments about how many times it will cut interest rates this year to whether it will cut them at all. The trigger for that shift is the worse-than-expected U.S. first-quarter inflation numbers. U.S. inflation rose 3.5 per cent in March from a year earlier. The number was higher than economists expected and higher than February’s 3.2 per cent. Core inflation, which excludes volatile food and energy categories, also rose more than expected on both a monthly and annual basis.

Swaps traders in the U.S. now see only one Fed rate reduction for all of 2024. That’s a significant change from earlier expectations of six quarter-point cuts. 

The disappointing inflation numbers caused the Fed’s chair, Jerome Powell, to say it was likely to take “longer than expected” to become confident inflation is moving toward the Fed’s two per cent target. Surprise, surprise – the Fed will be data-dependent. The only shock is that investors are shocked about this at all.

The Fed meets again tonight and tomorrow night and, so we will know more on Thursday. The Federal Open Market Committee (FOMC), however, will update its rate forecasts at the June 11-12 meeting. Back in March, the FOMC had pencilled in, by a whisker, three cuts for this year.

Here in Australia, local investors predict zero chance the cash rate will be cut this yearThat’s because we also received a surprisingly hot inflation report, which confirmed the easy wins to reduce inflation have been won, but bringing inflation down further will be harder and take longer.

Now, while no cut to short-term rates is a bit of a disappointment for markets, the Fed is doing something else in the background with longer-term rates.

And back at the beginning of April, the Fed also indicated it had neared agreement on a plan to slow the runoff of its $7.4 trillion in asset holdings.

The “runoff” is the passive action the Fed engages in, allowing the bonds it had purchased (which injected cash into the financial system) to mature without purchasing more bonds to replace those maturing.

Officials have been allowing up to $60 billion in treasury securities to run off every month and an additional U.S.$35 billion in mortgage-backed securities to mature every month. The process shrinks the Fed’s balance sheet, which topped out at nearly U.S.$9 trillion two years ago.

The pace of runoff is important because it can have an impact on bond interest rates. If the Fed buys fewer bonds, it reduces the upward pressure on bond prices. When bond prices rise, bond interest rates fall. If the Fed is buying fewer bonds, long-term rates could rise. So, if the Fed slows its runoff by replacing some of the bonds that mature with new purchases, the upward influence on bond rates is mitigated. The slowing of the pace of runoff can help to keep bond rates from going up and, by extension, help to stabilise financial markets.

But that’s not the silver lining. The real upshot is that the longer rates remain unchanged, the more investors become used to them being stable. When a ship stops rocking violently, its passengers can start to look out to sea and enjoy the view. When stability becomes accepted, investors will turn towards the other things that are moving, and for equities, that means a focus on earnings and growth. 

I believe we shouldn’t be too disappointed that rates aren’t being cut as quickly as hoped. Companies that are growing at low, mid and high double-digit digit rates will capture the attention of investors, as will small cap, mid cap and large cap equity funds that invest in them, and these should generate excellent capital gains for investors out to 2026.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Really appreciate your work Roger and especially the varied and regular updates on this blog; have been a long time follower of yours since the old (pre-GFC) ASX Investor Hour day meetings.

    Just one question; you alluded to the Fed allowing bond runoff, but is the Reserve Bank of Australia doing the same thing; indeed, are any others doing so ? (Bank of England etc.)

    • Thank you Chris, I have long appreciated your regular commentary, diplomacy and support. I am always pleased to see and read your comments. For the RBA at least, you can read some of their commentary about Bond purchasing HERE

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