JPMorgan Asset Management thinks Fed cuts could be deeper

The Federal Reserve may end up cutting interest rates more than it’s currently signaling as the US economy slows, driving a rally in shorter-maturity Treasuries, according to JPMorgan Asset Management.

“What the market’s pricing is roughly 1.5% of cuts and that’s probably a reasonable central case,” said Seamus Mac Gorain, head of global rates in London at the money manager, which oversees about $2.9 trillion. “In bad economic outcomes it could be, you know, quite a bit bigger than that.”

The asset manager is buying five-, seven- and 10-year Treasuries while going underweight 30-year bonds on its view that Fed rate cuts will cause the US yield curve to steepen, he said.

There’s been a huge disconnect in recent months about just how much the Fed is likely to lower its benchmark this year. Central bank policymakers in their quarterly dot plot are predicting 75 basis points of cuts by year-end, according to the median projection of the Dec. 13 update. The market is far more aggressive, with pricing climbing to almost 160 basis points in late December based on interest-rate swaps before easing back to about 140 basis points this week.

That divergence has whipsawed markets over the past year, and was a major factor behind the 180 basis-point range for Treasury 10-year yields during 2023. Many investors, including JPMorgan Asset’s Mac Gorain and Eurizon SLJ Capital Ltd., prematurely predicted an end to the Fed tightening last year but that didn’t eventuate as the US economy proved more robust than anticipated.

'BIG SURPRISE'

“It’s been a big surprise to us and others that actually inflation’s come down without” significant weakness in the economy that would have caused the Fed to cut rates, Mac Gorain said of his earlier forecast. “For most of last year we were thinking we would be in a recession environment, and obviously we haven’t been.”

Looking ahead at 2024, “given the amount of progress we’ve seen on a wide range of different inflation measures, it seems much more likely the central banks can get back to target,” he said.

Benchmark 10-year yields may fall about 50 basis points from their current level to around 3.50% this year as the Fed loosens monetary policy, Mac Gorain said. 

The best trades going ahead look to include “steepeners anchored in the belly of the curve” as the curve tends to steepen a lot during easing cycles, he said.

Mac Gorain helps oversee a number of strategies at the money manager including the Global Government Bond Fund that’s returned 1.1% in the past year, according to data compiled by Bloomberg. He also helps manage the EU Government Bond strategy that’s gained 3.7% in the same period.

JPMorgan Asset’s base-case scenario for the US economy remains a soft landing but a recession can’t be completely ruled out, which presents a compelling reason to own Treasuries, Mac Gorain said. 

“1% real yields is the level you get to in a recession,” he said. “The advantage of owning duration here is that you get at the very least a reasonable real yield.”