Michael Krautzberger, Global CIO Fixed Income at AllianzGI, has commented ahead of the US Federal Reserve meeting.
Fed to keep rates on hold for second consecutive meeting; US government policy uncertainty driving future rate cut expectations.
- We expect the US Federal Reserve to keep rates on hold at the 19th March meeting, leaving the Fed funds target range unchanged at 4.25%-4.50% for the second consecutive meeting.
- Market sentiment on the US economic outlook in 2025 has shifted since the turn of the year given the trade and fiscal policy uncertainty from the new Trump administration.
- US economic data has cooled, with the outlook for consumer demand and business sentiment clouded by US government policy. US equity and credit markets are creaking under the weight of this policy unpredictability.
- Fed Chair Powell, in his most recent comments, reiterated his belief that “the US economy continues to be in a good place”, but financial markets are less convinced.
- At the start of this year, barely one Fed rate cut in 2025 was priced into short term interest rate markets; in recent weeks, pricing has moved towards three rate cuts. 2-year US Treasury yields, at 4%, are back to where they were ahead of the US elections last November.
- We think that the best way to play the current macro and policy environment in the US is via curve steepeners. However, given recent market volatility, we prefer to trade tactically around structural positions, such as in our curve steepener views.
The market euphoria that greeted the Trump re-election and Republican clean sweep in last November’s US elections are a distant memory. The trade and fiscal policy of the new Trump administration – and the risks of retaliation from its closest trading partners – has derailed some of the more bullish growth expectations for the US economy in 2025, with the relative US growth outperformance versus the rest of the world now also being questioned.
Having achieved an average annual real GDP growth rate of 2.7% between 2022 and 2024, market expectations of another above trend year for US growth are quickly being revised lower; in fact, a sub-trend (i.e. below 2%) growth outcome for 2025 now looks increasingly likely. Market probabilities of a recession over the next 12 months have also risen, although this outcome is a tail risk rather than a central scenario at this current juncture. Much will depend on the Trump administration’s policy reaction function; Trump could well dial back some of his more hawkish tariff rhetoric if larger US downside growth risks begin to materialise and if equity and credit markets take another lurch sharply lower. Even against this backdrop, government spending cuts and tighter immigration policy will still be a drag on growth this year.
In the near term, recent US data has clearly lost its shine. The health of the US consumer is causing some concern, with recent earnings guidance from US retailers reflecting some of the strains they are seeing in household balance sheets. Consumer sentiment surveys are increasingly highlighting the impact of tariffs; one-year inflation expectations have risen to 4.3% in the latest Michigan consumer sentiment survey and households’ fear a squeeze on their disposable incomes.
The US unemployment rate, at 4.1%, remains low by historical standards, but recent labour market data is beginning to signal a weakening trend even before the likely impact of future fiscal tightening. In particular, small business hiring intentions are stalling as tariffs on critical imports hit the cost base and lower capex investment intentions.
On inflation, although the Fed revised up its 2025 core PCE inflation projections to 2.5% last December, the current proposed tariff package raises renewed upside risks, which is likely to be reflected in the Fed’s latest projections at the March meeting.
The Fed is having to navigate downside growth risks, but with inflation risks looming over the horizon. In the very short term, the Fed is likely to be biased to keep some policy restraint in place in the face of the inflation threat, but that could quickly change. Insurance rate cuts to stem downside growth risks may well be back on the policy agenda in the coming months.
We think the best expression in portfolios to reflect this market environment is via US curve steepeners.
