Update Bonds: The Federal Reserve remains on hold
On 18 June, the Federal Open Market Committee (FOMC) voted to hold the federal funds rate unchanged. They also released new economic forecasts, predicting weaker growth, higher inflation and higher unemployment for the year. Interest rate projections show a split among policymakers. Ten officials expect at least two rate cuts before the end of 2025, while seven foresee no rate cuts this year.
The Federal Reserve (Fed) officials and economists expect the US administration's expanded use of tariffs to weigh on economic activity and put upward pressure on prices. Fed Chair Jerome Powell said that the central bank wants to see the impact of tariffs before adjusting policy. Initially, the markets responded positively, with US Treasuries rallying. However, this momentum soon halted. Spreads on credit assets were almost muted and are currently trading at slightly higher levels than before the trade war started on 2 April.
Looking at inflation month-over-month it shows a downward trend in both the US and Europe. The inflation rate has passed its peaks from 2022 and is now coming back to acceptable levels for central banks. Traders expect two more rate cuts from the Fed this year, while we expect the Fed to remain on hold. Meanwhile, the European Central Bank (ECB) showed a more cautious tone in its last meeting, indicating that perhaps the easing cycle is approaching its end. However, we still anticipate more rate cuts from the ECB.
This scenario aligns with our expectations: a cautious Fed and a dovish ECB. This situation bolsters our confidence in our portfolio position. We favour European over US assets, which is expressed in our overweight position in European government bonds. In the credit market, high-yield and emerging market bonds are mostly exposed to US duration and their spreads are expensive. Therefore, we keep their underweight and choose to invest in safer securitised bonds, which could benefit in case the economic situation deteriorates.