Ladies and gentlemen, the weekend! In this space each week, Greg and I share some of our favorite articles, notes, and graphics from the past week along with our commentary. Please feel free to provide feedback and forward along to others if you enjoy. We appreciate you taking the time to read. 

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Has The Fed’s Rate-Hiking Cycle Peaked?

“This week’s news on consumer inflation supports the case for expecting that the Federal Reserve’s interest rate hikes are approaching the end game. The basic calculus is that are disinflation persists, the odds rise that the central bank will pause its policy of tightening monetary policy.

US consumer prices rose in June at the slowest pace since March 2021, providing more support for expecting that the Fed’s will put rate hikes on ice. Core inflation’s descent is still relatively sticky, which leaves more room for caution compared with reviewing headline comparisons, which are lower primarily due to softer food and energy prices. But looking a broad set of inflation metrics indicates that disinflation is robust.

Meanwhile, Fed monetary policy remains moderately tight, based on a simple model that compares the Fed funds target rate to unemployment and inflation. With inflation easing at a solid pace, the central bank may be convinced that it can put rate hikes on pause and allow the current moderately tight policy stance to put downward pressure on prices."

Wednesday’s Consumer Price Index (CPI) report showed that headline inflation had slowed to 3% over the trailing year, which was the slowest annual growth rate since October 2021. Core CPI also slowed to 4.8%. Both were below economists’ expectations.

The Federal Reserve has basically locked in a 0.25% increase at their next meeting in a couple of weeks. They are unlikely to try to reverse course this late; however, inflation data like this should spell the end for future hikes. 

Stock markets rallied in response and continued their upward trend.

Treasury Yields: The Long and Winding Road to 5%

“For investors a 'higher for longer' peak (or 'terminal rate') for the federal funds rate in this cycle has several implications:

1. The downside potential in intermediate- to long-term yields for this year is likely higher than we previously expected. Intermediate- to long-term rates reflect expectations for the path of the fed funds rate plus a risk premium. Continued Fed tightening will likely pull rates higher across the yield curve. Rather than the 3.0% to 3.25% year-end target we had previously expected for 10-year Treasuries, a lower bound of about 3.5% is more likely and a re-test of the 2022 peak of 4.25%-4.35% is possible.

We expect the yield curve to remain inverted, but it is already near historically low levels last seen in the early 1980s. At a spread of about -100 basis points between two- and 10-year yields, more rate hikes are likelier to pull up yields across the curve than to deepen the inversion to new lows.

2. Volatility is likely to rise. In the bond market, volatility reflects uncertainty about the path of interest rates. With the Fed signaling the potential for more rate hikes and the market discounting the potential for rate cuts early next year, the tug-of-war between the market and the Fed will likely mean volatility stays elevated. It has retreated from the peak level reached in March but is well above the long-term average….

Now that short-term Treasury yields have reached 5%, further upside is likely to be limited. Although the economy has remained resilient in the face of the most rapid pace of rate increases since the late 1970s, inflation is cooling. Moreover, the Fed is likely near the end of its rate-hiking cycle, which would allow intermediate- to long-term yields to move lower over the next year. Ten-year Treasury yields have tended to peak within about six months of the peak in the fed funds rate in past cycles. If that pattern holds, then current yields may be near their highs.

For investors, current yields present an opportunity to extend the average duration in portfolios and lock in the highest yields in a decade for long-term cash flows. However, given the risk that the Fed overdoes its tightening and tips the economy into recession, higher-credit-quality bonds—like investment-grade corporate and municipal bonds—look more attractive than lower-rated bonds. In addition, Treasury Inflation Protected Securities (TIPS) provide an opportunity to lock in positive real yields and mitigate the impact of inflation.

Heightened volatility is likely to continue to be a feature of the higher-interest-rate environment. A laddered portfolio of high quality, diversified bonds that helps take some of the risk out of market timing can be a good way to manage through the rest of this interest-rate cycle.”

Charles Schwab updated and released their outlook for U.S. Treasury rates as well as some other fixed income sectors. It’s been a long road to get back to 5% in short-term government bonds after the Great Financial Crisis, but they will likely not stay there for too long.

The outlook is for intermediate to long-term yields to fall over the next year with short-term rates to follow. That dynamic may steepen the yield curve inversion in the near term before it unwinds.

Did the SEC Just ‘Kill’ Institutional Prime Money Market Funds?

“Members of the Securities and Exchange Commission voted earlier this week to change the rules governing money market funds, a decision that regulators and others say might cause some funds popular with institutional investors to lose assets or shutter. Regulators have struggled to rewrite the rules since 2008 when the government stepped into temporarily guarantee the funds during the global financial crisis.

Under the new rules, money market funds have higher liquidity requirements. Their total assets required to be easily-sold — liquid — on a daily basis increased from 10 percent to at least 25 percent, while their weekly liquidity threshold increased from 30 percent to at least 50 percent. Regulators said those changes will provide a more substantial buffer in the event that investors race to redeem their funds, as they did during the global financial crisis and at the beginning of the COVID-19 pandemic in March of 2020.

The new rules also forbid money market funds from temporarily suspending redemptions through a traditional gate or by charging investors fees if their weekly liquid assets fall below a certain threshold.

Additionally, the new rules will require institutional prime and institutional tax-exempt money market funds — those used by pensions, endowments, and other institutions — to charge investors liquidity fees when a fund experiences daily net redemptions that exceed 5 percent of net assets…

The SEC commissioners voted 3-2 to approve the rules, which will be sent to the federal register and go into effect within 60 days. Funds will have 12 months from the effective date to comply with the rules…

Before the vote on the rules, [dissenting Commissioner Hester] Peirce bluntly asked: 'Are we trying to kill institutional prime funds?'"

We’re finally seeing some of the regulation fallout from the COVID pandemic market upheaval. It will be a wait-and-see for the real-world impact on institutional money market fund rates (if any). The ability to actively manage cash equivalents like U.S. Treasuries, CDs, and other instruments may be an advantage if it comes to it.

“Q2 2023 is currently back close to the average pattern of gradual downgrades before earnings start. The three previous quarters saw much sharper downgrades as can be seen. So normal service is resuming for now. As the graph and report highlights, on average earnings then beats by an average of around 4.9%...

Reid also notes two other interesting factors in his report (which is highly recommended):

• During the average earnings seasons, the S&P 500 up 2% over the first four weeks of reporting.

• Earnings season is about 31% (16 weeks) of the calendar year, so its contribution of 8% is a substantial part of annual US equity returns.”

Thanks for reading. Have a great weekend!

RBG Wealth Advisors LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.