What rate cuts, the bond sell-off mean for investor portfolios

But let's talk about what people should be doing in their portfolios, if anything, with the action that we've seen. Alex Morris is joining us now, FM Investment CEO and CIO for this week's FA quarter brought to you by Capital Group. Alex, it's great to see you. It's been a minute. So, you have been watching this very closely, as have we all, obviously. So how do you think about the sort of knock-on effects in the market, what you change in your fixed income portfolio itself, and then kind of around that, what people need to be aware of.

Yeah, I think higher rates have seemed to spook some people, which it's kind of funny because those are the same people who eight years ago were complaining, we can't find any return in the fixed income market. So, you got to choose your your poison here. Now, it's it was really an interesting auction, which I know most folks aren't going to go home and talk about Treasury auctions, but we should talk about what happened at the 10-year auction. Tremendous demand, which was great. We were worried that we would fall short of demand. But the government borrowed money at the highest rate it's done so since 2000. So, a bit of a mixed bag there. The good news is though, there's an actual return to be had now in the rate space and although it's all it's impossible to time the market and and all of the catch the falling knives metaphors will be absolutely right. As a a newsletter writer put it to the newsletter crew and me today when asking about buying more of U30, UTHY as we put it, is is his answer was, supersize it. Because if you're in and you believe this is going to work, that's going to be your best return. It's just going to be a little bumpy along the way.

Alex, you know, you you you write, uh rates come down eventually. The question is why. One answer, an actual economic oopsy that forces the Fed to cut meaningfully. You know, I don't think anyone's talking about cuts right now, so I'm I'm fascinated to hear from you what that might actually look like. Like what are what are the scenarios you're game planning for that?

Well, I think there is one person who's talking about cuts all the time. It's the president. And I think that's the most meaningful question because the president has also threatened to use trade policy in lieu of monetary policy in an effort to get rate cuts. and he does have the ability to do that. And I think the biggest threat to the Fed today is the administration creating a situation where rates are artificially brought down either through yield curve control or need to be brought down in a normal way because something else has gone wrong. And the the the realm of things that could go wrong is big and scary and and most are well avoided. But it's unusual that the president is so invested in the 10-year. And I get it. I mean, the 10-year drives mortgage rates and mortgage rates are, you know, a big part of the American dream. particularly with mid-terms coming up, that's top of mind for a lot of politicians, but practically speaking, there's no great economic reason today for rates to be cut, much the opposite. That doesn't mean there aren't a lot of political pressures that very much need to see the 10-year and the 30-year come down dramatically.

Hey Alex, Pross here. You know, we've been debating about debating this for weeks now. What part of the whole sort of rate spike in recent recent months is due to, you know, just fiscal spending that's sort of bigger than what most people expect and think that's unsustainable.

I think it's a good part of it, but it's not a new phenomenon, right? It was just nice that we crossed 40 trillion so we had a chance to talk about the debt as a problem. But 20 years ago, this was all the political chatter. Fiscal responsibility, there was always the party running on fiscal responsibility and the party who was spending. Now, both parties pretty unabashedly run on the, let's spend more strategy. and it seems to work. They keep getting reelected on that that uh ticket. But this is a problem. It is getting worse. The government is now making it worse because the more they have to borrow at high rates, the faster that flywheel works against them. But I don't know that the demand at the auctions or just general conditions are giving at least the political side of the the the sphere enough ammo to say, we should stop just yet.

And by the way, Alex, Pross asked you that because he's trying to settle the argument, the ongoing argument that we have about it. Because I don't think that the current uh increase in yields is that tied to these debt concerns. As you say, it's sort of like always low level in the background. But that that's just me. I think it's I think it's more some of the other, some of the other stuff that we've been watching. But maybe maybe you're I think your answer could cut both ways. Maybe he can maybe he can take some credit for this too.

There's certainly something there uh Pross for for your side of the argument, but you you couldn't argue against oil and a handful of other things that are just making economic conditions hard. And a Fed that seems to be very split. If you read the FOMC minutes, you got a 12-0 vote, but there are two totally different camps on the fundamentals of how inflation works and why. And that will ultimately spill out into more contentious votes in the next in the coming weeks and months.

Alex, I want to zoom out a little bit here. You know, you go back to the beginning of the year, one of the narratives we saw emerge was that the global market outside of the US was set to do really well this year with maybe some weakness in the US. We've not seen that play out exactly like that, and now we see the bond sell off really rippling out globally. You look at what's happening in France, in the UK, of course, here in the US. When you're talking to clients about balancing the US versus global allocations, you how how are you how are you telling them to weigh that? And what what's what are you what's your thinking there?

You know, this is one of the hardest conversations to have with any asset allocator. You're yourself even when you look yourself in the mirror is, you have to be internationally diversified even though all of the recent experience tells you that's going to sting a little bit. We still think it's it's important. Uh we saw two years ago that international, largely international value did really well. We think this has been a growth story, right, earlier talking about all of the AI spending build that's going on. That's ultimately a growth story, and when you're looking for growth, you come to America. That's not generally been the international winning story. So, we're we're understanding that it's hard to believe in that all the time, but mathematically, we agree in the long run, that's going to win out and I think it's still a great place to be, even though I get it, it's a hard conversation to have.

Um and Alex, when we try and figure out where rates are going here in the US. You guys um developed something fun called Warsh GPT, which try like tries to AI-eyes um Kevin Warsh and what he might do next. Um, so what what's it telling you these days, especially since like Warsh himself hasn't said much, but as you know, a lot of other Fed officials have been very vocal recently.

Yeah, it's funny because we Kevin Warsh hasn't said much about the path of rates now, but in the past, he's had an awful lot to say. So there's a lot to train that model on. And it seems to be that the Fed is as a general rule, seems to want to hold, but is trying to build credibility. And the the model says, hold every time we can, but sort of give way to rate hikes when when necessary. But if you're going to do that, make absolutely no promises about how much higher you're going to hike or when you're going to cut. And the model is is starting to look at and say, maybe it's time to just hold on. Uh certainly, it looks like doing nothing in October would be preferential just for political reasons and the jobs report seems to give us enough room to say that they could just take a pass on October. Ideally, if they could conveniently cancel the meeting, they'd probably like to do that, but uh that won't happen.

No.

Imagine if we'd had a Powell GPT. Uh Alex Morris, thank you so much for joining us. Your insights always appreciated.