State Street (NYSE: STT ) Global Advisors, the $3.6 trillion asset manager, is betting against the prevalent higher-for-longer sentiment in global bond markets, predicting a significant decrease in Federal Reserve interest rates for the coming year. Contrary to market expectations, the firm anticipates at least a full percentage point cut — double what markets are currently pricing in — in response to an expected slowdown in growth and inflation.
In an interview on Tuesday, Lori Heinel, Boston-based chief investment officer at State Street, said, "The Fed fund rate needs to drop pretty dramatically next year. We think at least four rate cuts — so 100 basis points and maybe as much as 200." The firm has increased its holdings of longer-dated Treasuries in anticipation of these changes.
Heinel argues that the Fed's hiking cycle has concluded and that the current policy is sufficiently restrictive, considering the delay with which tightening impacts the economy. She predicts US economic growth will slow to 1.1% next year, with inflation moderating to just below 3%. "That will give us room to get longer yields back to a more appropriate risk premium," Heinel added. "We are buyers of rates here, there’s good value."
This contrarian stance challenges the higher-for-longer expectations dominating markets. These expectations have led traders to reduce bets on next year’s Fed rate cuts from 150 basis points a couple of months ago to half a point now. This shift in narrative has resulted in a significant selloff in long-dated bonds and pushed yields to multi-year highs, with the US 30-year rate reaching its highest level since 2007 on Tuesday.
Despite predictions of an economic slowdown, Heinel sees relatively resilient consumer demand supporting Wall Street stocks. State Street continues to hold nearly 10% of funds in cash but leans towards buying more bonds. The firm has been increasing its overweight position in long-duration Treasuries while remaining overweight in US equities. Concurrently, it has switched to underweight on European equities due to the region's energy vulnerability and maintains a negative outlook on Asia, considering China's disappointing post-pandemic recovery.
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