A Fed Mistake?

August 01, 2019

As we see it, the measures of success for the U.S. Federal Reserve (Fed) July meeting policy decision were for the yield curve to steepen and for the U.S. dollar to weaken. The opposite happened: the curve flattened and the U.S. dollar rose. This signals to us that the Fed made a policy mistake by cutting rates 25 basis points (bps) instead of 50.

We have been strong advocates of a 50 bps rate cut despite the overwhelming market consensus for a 25 bps cut. The Fed delivered on market expectations, but missed on meaningful guidance during its press conference. The market expected a 25 bps rate cut alongside dovish guidance, but Fed Chairman Jerome Powell did not communicate this to the market. Our rationale for a 50 bps cut was as follows:

The Fed is missing low on its inflation target with the core personal consumption expenditures price index (PCE) at 1.6%
The Fed needs to steepen the yield curve
A vicious cycle exists: A stronger U.S. dollar pushes inflation lower and further away from the Fed’s target. This is especially true if other global central banks adopt easier policies that would strengthen the U.S. dollar on a relative basis.
The Fed needs to overweight the importance of reaching their inflation target. Why?
- Because disinflation reduces long-term trend consumption (70% of gross domestic product)¹
- Manufacturing, capital expenditures and the supply side of the economy are all slumping (globally too)

Nevertheless, this event does not serve as a catalyst to materially change current portfolio positioning at the moment.

RISK CONSIDERATIONS
There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In the current rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest-rate environment, the portfolio may generate less income. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities (“junk bonds”) are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging-market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).

August 2019