Jessica Schmitt (0:13)
Welcome, Doug, to our brief pre-holiday video update.
Douglas Gimple (0:18)
Thank you, Jess, for having me here. I appreciate it.
Jessica Schmitt (0:22)
Well, I'm excited to close out the year with you, Doug. We know that everybody is very busy this time of year, right before the holidays. So, in lieu of our traditional 20-minute podcast, we are going to do a brief, hopefully, five to seven-minute update here on video. So thank you again for joining us. We are going to cover, Doug, today, two key topics: One, the Fed meeting, which it's December 18th, the Fed just met and announced another rate cut. We'll come back to that. But we're also going to talk about risks and opportunities for fixed income investors as we head into 2025. So, let's start with the Fed. As we now know, they cut another 25 basis points, which was widely expected, and that totals a full percentage point since September. Share with us your thoughts and takeaways from the meeting today.
Douglas Gimple (01:13)
Yeah, no surprises at the actual action. I mean, everyone assumed it was going to be 25 basis points, and the Fed did nothing to dissuade the market from believing that. But what I think was most interesting was we got a new dot plot, which is kind of their projection of what the future will hold, and that changed. They pulled another 50 basis points off next year's expectations. So now 2025, they're looking at 50 basis points in cuts. I was just listening to the press conference. Someone boldly asked him what the timing on those would be, to which he, of course, said, we have no idea, and I'm paraphrasing here, but that it's all going to be data dependent. So, you could call it kind of a hawkish-dovish meeting: Dovish in that they cut another 25 and hawkish in that they rejiggered expectations. And what's interesting is that if you look at Fed fund futures, they're right in line now, or at least they were before I came in, with 50 basis points and cuts.
So, you look at throughout this year, there was this difference between the market expectations and the Fed, and they got in line and then they got out of line. And right now at least, going into the end of the year, they're back in line. So, the expectations next year for 50 basis points with the caveat that we don't know what's going to happen. Things are going to change today, tomorrow, and the Fed will change their outlook and the market will change their outlook as well. But for right now, that more hawkish type of tone with a cutback in what the reductions would be for 2025.
Jessica Schmitt (02:49)
And the other big unknown, as we've talked about before, is now the new administration Trump 2.0. We don't know what's going to happen with two big things: tariffs and deportation, which could impact inflation, which could move the Fed one way or the other.
Douglas Gimple (03:07)
Right. And what is being said and what will actually occur are probably two drastically different things. And if that's one thing we learned from Trump 1.0 is that he'll put forth a bunch of ideas and by the time they're executed, they're a little bit different than maybe what had originally been talked about. And I imagine we'll see something like that again. But if we take at face value, what he's talked about with tariffs, which were, I think, 10% across the board, 60% with China, potentially 25% with Canada and Mexico. Bottom line, however you think about tariffs, they're inflationary for the end consumer because regardless of who pays that tariff, that is going to come back on the consumer. And it's simply, if I’m selling shirts and I buy a $10 shirt from China and that shirt now costs me $16, I'm going to have to increase the amount that I charge to the end consumer to get my money.
And so that will impact inflation. And then the mass deportations, it really depends on what we see. I've seen estimates that to deport one million people, which I know he's talked about 11 million, but if we deport one million people, the cost alone is in the multiple billions of dollars. And that's just the actual cost of the deportation. The impact to the consumer, the impact to the labor market is very far reaching and also inflationary, because you have a smaller labor pool, you have a smaller consumer pool. And so that really remains to be seen what that impact will be. But the expectations are that both tariffs and mass deportations will be inflationary in some way. And that could shift what we were just talking about with the Fed. That could shift their expectations as we move through the year and see what these programs actually look like.
Jessica Schmitt (05:04)
Just a quick note, we're not going to get too far into your monthly commentary, which is available now on our website for the month of December. It was called “The Fed Embarks on an Easing Cycle and Rates Go…Higher?,” and we did see the 2-year and the 10-year go up today after the Fed meeting. Maybe just give us a little bit of insight there for folks who may not have a chance to have read the commentary quite yet.
Douglas Gimple (05:29)
Yeah, it's all about expectations at this point. I mean, we've seen now that we're through today a hundred basis points in easing from the Fed, but the 2-year and, more importantly, the 10-year have all moved higher and some substantially so. And that influences mortgage rates, auto loans. And so though the Fed has been easing, it's had the exact opposite effect of what you may have expected. Now, mortgage rates are off their highs from last year, year and a half ago, but they're still high, and they haven't come down. And so, that's one of the disconnects that we've seen in the market. I imagine that's going to continue. As you said, rates have backed up today, and that's really based on expectations for the future that the easing cycle is not going to be as we'll say, drastic as originally expected. And that's the market adjusting to that.
And that's why we're seeing that on the longer end, and we talk about it a bit more. And one of those things we've already discussed a little bit, the unknown with Trump 2.0. One of the things that I think he embraces is that uncertainty of what he's going to do. And we had the kind of post-election immediate euphoria of, hey, we know who won, and we don't have to worry about legal proceedings or protests. It was over and done with. And that has faded as we hear more about his plans, and we try to understand what Elon Musk and Vivik Ramaswamy are going to do to government spending and all these unknowns. And so I think that uncertainty is leading people to back away a little bit. And that's why we've seen rates continue to creep higher. And then today's move by the Fed, again, a lowering, but a reduction of the lowering for next year, the future path of rates is uncertain and maybe only slightly lower going forward. And that's looking at it right now, there's so many different things that will impact that as we move forward.
Jessica Schmitt (7:32)
Okay. Well, let's talk about moving forward, Doug. What are some risks going into 2025 for fixed income investors? And also, more positively, what are some opportunities for fixed income investors?
Douglas Gimple (7:44)
Yeah, I think the risks are a lot of what we've already talked about — that uncertainty of inflation, the labor markets. Inflation has kind of held the line at 3.2% to 3.3% over the last four to five months on a 12-month moving basis. And labor market recovered nicely from that, I think, it was 10,000 or 12,000 jobs added in October. We saw a nice rebound in November. We don't know how that's going to progress. So that uncertainty, I think, remains a risk because that will influence how the Fed will act going forward. And then the other uncertainties that we talked about: How do deportations progress? What happens with tariffs? What happens with Canada and Mexico? All of these things. And what happens, I think, it's kind of avoided the headlines, but what we see with the government itself, we just, I think today got an extension so Congress can go on vacation of the debt ceiling. They really, they just again, kick the can down the road down to, I think, it's now March 14th is when they have to now reassess and reapprove an extension before the government shuts down. We got past it for the holidays, but it's still out on the horizon, which it always will be. So, I think that's another risk that's gotten less publicity because it seems to focus on Trump 2.0 and the Fed and the labor markets and inflation.
From an opportunity standpoint, what we're seeing in the market is that corporate spreads really tightened throughout the year. And whether it's investment grade or high yield, you're still near historic lows, historic tights, you're well below the historic average, whether it's investment grade and the, call it 75 to 80 basis point range. And the historic average, at least since the turn of the century, is 145-150 basis points.
So, a lot of tightening there. I think it's driven by investors liking that nominal level of yield that they're getting. And that continues, and I think that continues into next year. The worry is that there's some kind of trigger that creates that spread widening. We just don't know what it is. But opportunities wise, we still like the securitized market, or at least parts of the securitized market because even though we've seen pretty significant spread tightening in those parts of the market, so I'm talking resi mortgages, CMBS (commercial mortgage-backed securities), ABS (asset-backed securities), there's still some room to run, we believe, because when you look at those areas of the market relative to investment grade corporates, and even some areas relative to high yield corporates, you're still getting a little bit more incremental yield or spread that can add some value. But we've seen some pretty impressive numbers this year across fixed income, which is a nice kind of reminder of what fixed income can be. After what we saw in 2022, we saw this nice recovery near the end of 2023 and really throughout 2024.
So, we think the opportunities are still there, but as always, you have to be selective. You have to be careful, you have to really understand what you own. But in doing that, we think you can find some opportunities, but we also recognize it almost feels like the market's priced to perfection at least a lot of the different parts of the market are priced to perfection. And so, a little more caution and maybe holding a little more cash just to be ready when we do see those opportunities present themselves.
Jessica Schmitt (11:29)
Okay. Well, that sounds good, Doug. I look forward to catching up with you in the new year and reviewing all the unknowns that will become known. So thank you again for your time today, and we wish everyone who is watching a wonderful holiday season. Thank you, Doug.
Douglas Gimple (11:48)
Thanks so much, Jess. Appreciate it.