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We saw a sizable risk-on rally at the end of 2023 following a surprisingly dovish pivot by the Fed. Investors saw the strongest signal yet that policy rates had peaked, with multiple cuts now expected in 2024. While ‘higher for longer’ interest rate concerns drove challenging returns in the fall, encouraging inflation data and a normalizing labor market cleared the way for the eventual easing of monetary policy, sparking a 'Santa Pause' rally.
Recent data is indeed encouraging, but we believe market expectations for rate cuts are both too soon and too large. We see the Fed pause extending through the first half of 2024 and are waiting for additional clarity that stickier components of inflation have receded. We see opportunities even amid a complex macro backdrop but support a balanced approach that matches high quality assets with targeted risk taking. Market risk remains and the strain on U.S. consumers is evident in falling personal savings rates as well as rising auto loan and credit card delinquencies.
On the flip side, opportunity cost has entered center stage. While high cash rates drove record flows into money market funds in 2023, recent months have revealed the cost of being over-allocated to cash -- missing out on market returns. We believe now is the time to reinvest, as the pause period between the Fed's last hike and first cut has historically delivered even stronger performance than the beginning of a cutting cycle.
We also see opportunities to step out of cash and into intermediate-term bonds. Historically, bonds have returned nearly twice as much in a pause period than after the first cut – underscoring the urgency to invest that we do not yet see reflected in many advisor portfolios.
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