U.S. Resilience Scuppers The Case For Early Rate Cuts
For ETF investors, the bigger message is not simply that cuts are delayed, but that the rate path remains uncertain enough to punish rushed duration bets. When policy easing gets pushed back, longer-duration bond ETFs can remain sensitive to every upside surprise in inflation or payrolls data. That makes the timing of a move out the front end of the curve more important than the headline view that rates will eventually fall.
In this setting, the distinction between carry and duration matters. Cash-like or short-duration bond ETFs may continue to offer a relatively defensive way to earn yield while limiting price volatility, especially if inflation proves sticky for longer than markets expect. Investors who already hold intermediate or long-duration funds may want to think less about โmissing the cutโ and more about whether their portfolio is being compensated for the interest-rate risk they are taking.
The article also highlights a familiar portfolio tension: economic data can look resilient even as forward-looking surveys soften. For ETF allocators, that argues for avoiding all-or-nothing positioning. A staged rebalance across equity, core bond and short-duration exposures can be more robust than a single directional call on the Fed, particularly when the market is pricing only a narrow margin for error.
Long term, the key issue is not one meeting, but the path of real rates and inflation normalization. If inflation cools gradually while growth slows, bond ETFs with lower sensitivity to duration shocks can still play a useful stabilizing role. If the disinflation process stalls, investors may need to stay selective about how much term risk they own and why.
Ongoing strength means a June rate cut looks unlikely
The US economy continues to show remarkable resilience in the face of high borrowing costs, tight credit conditions and a weak external backdrop. It appears on course to grow at a 2.5% annualised rate in the first quarter. We already know it added 829,000 jobs in the first three months of the year. With inflation still closer to 4% than the 2% target โ and Wednesday’s numbers were a surprise โ we have to admit that the likelihood of imminent policy easing from the Federal Reserve appears more remote than previously thought. Financial markets are now merely pricing 5bp of easing for the June FOMC meeting, implying around a 20% chance of a 25bp rate cut. For the Fed to deliver, we suspect we are going to need to see the next two core inflation prints coming in at 0.2% MoM or below rather than 0.4% and a clear slowdown in payrolls growth from around 250,000 per month to well below 150,000. This is possible, but we are not confident. We now think a third quarter start point for Fed easing, either in July or, more likely, September, looks like a more credible call than June.Business surveys suggest the economy is weaker than reported by official data
But surveys still suggests a marked slowdown is coming
That said, the divergence between strong official activity data and much weaker survey evidence is stark. The ISM indices are at levels historically consistent with the economy expanding at a 0.5% YoY rate โ significantly weaker than the 3% YoY GDP rate recorded in the last quarter of 2023. The employment components of these indices have been in contraction territory for several months. Arguably the most reliable labour market indicator in recent times, the National Federation of Independent Business hiring intentions series, suggests payrolls growth will slow meaningfully over the next three to four months to perhaps below 50,000 per month.Meaningful interest rate cuts remain our call
At the same time, manufacturing orders are doing nothing, small business optimism is at the lowest level for 12 years, real household disposable incomes are flatlining and pandemic-era accrued savings are largely exhausted, according to San Francisco Fed calculations. We strongly suspect a slowdown is coming, but that may not be evident in official data until later in the year. Sticky inflation is further scuppering the prospect of near-term rate cuts, so our previous call for 125bp cuts this year looks like too much of a stretch. We are now forecasting 75bp of policy easing in 2024. We do expect inflation to converge on 2% as cooler economic activity and subdued labour cost growth help dampen price pressures. This should allow the Fed to cut rates further in the first half of next year, which would allow the target rate to settle at 3.5%. For the Fed to cut further, it would likely require a systemic shock, most likely through a reignition of small bank financial fears triggered by commercial real estate or consumer loan losses. Original PostEnjoyed this article? Sign up for our newsletter to receive regular insights and stay connected.