By Nigel Green
Despite the Federal Reserve’s preferred inflation gauge, the PCE report, moving in the right direction last week, it’s likely that there will be not enough evidence for the central bank to cut interest rates in 2024.
The personal consumption expenditures price index excluding food and energy costs increased just 0.2% in April, in line with most expectations. Core PCE was up 2.8% on an annual basis, or 0.1 percentage point higher than the estimate.
Including the volatile food and energy category, PCE inflation was at 2.7% on an annual basis and 0.3% from a month ago.
The data will have been welcomed by the US central bank and by investors who are keen for inflation to fall back close to the Fed’s 2% target so it can pivot on its monetary policy and start cutting interest rates.
However, whereas last year inflation was coming down quite quickly and the progress was at a pace due to the supply side drivers having faded, the trajectory for the ‘last mile’ to the target is proving incredibly sticky – it feels like walking through treacle.
This data is not enough to convince the cautious officials at the Fed to cut rates. Inflation appears to be stuck in a range and there will need to be several consecutive months of undeniable proof that it is finally moving down at a clip, rather than a crawl, before any action is taken. This is simply not happening at the moment and there’s no reason to suggest it will next month or the month after that.
Some commentators also believe the Federal Reserve won’t cut interest rates in the run up to an election – and the US presidential election takes place in November – to avoid appearing politically motivated.
As such, we expect that there’s a risk that we might not see a rate cut until 2025.
In an environment where interest rates are expected to remain higher for longer, investors should consider rebalancing their portfolios to mitigate risks and capitalize on new opportunities.
Higher rates often lead to lower valuations for growth stocks, which rely heavily on future earnings. In contrast, value stocks, which trade at lower price-to-earnings ratios, can provide more stability. Companies with strong balance sheets, consistent cash flow, and the ability to pass on higher costs to consumers can perform better in such an environment.
Also, when interest rates rise, bond prices fall, particularly for long-term bonds. By reallocating funds to bonds with shorter durations, investors can reduce interest rate risk. Short-term bonds are less sensitive to rate changes and can be reinvested at higher rates as they mature.
Companies that consistently pay dividends can provide a steady income stream, which is attractive in a high-rate environment. These stocks offer a combination of income and potential capital appreciation, making them a suitable alternative to fixed-income securities.
Of course, higher US interest rates will also strengthen the dollar, impacting international investments. Diversifying into regions with different economic cycles or more favourable interest rate environments can provide a hedge against currency risk and global economic shifts.
Against the expected backdrop, maintaining a portion of the portfolio in liquid assets can provide the flexibility to take advantage of new investment opportunities or market dislocations. This could include cash equivalents or highly liquid, short-term investments.
By considering these strategies, investors will better position their portfolios to face the challenges and opportunities presented by a prolonged period of higher interest rates.
Regularly reviewing and adjusting the portfolio in response to changing economic conditions is essential for long-term financial health.
While I maintain there’s a threat there will not be a cut until next year, market pricing on Friday morning signalled a probability that the first move likely won’t come until November, at the Fed’s meeting that concludes two days after the presidential election. Time will tell.
(Author is deVere Group CEO and Founder)