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Top bond forecaster says to expect higher yields, a reacceleration of the economy and fewer interest-rate cuts

Joe Brusuelas, chief economist at RSM, has more than 20 years of experience analyzing U.S. monetary policy, labor markets, fiscal policy and international finance. He regularly briefs members of Congress and other senior officials on the effects of federal policy and the factors by which executives make business decisions. In December 2023, Brusuelas and the economics team were listed on Bloomberg’s Best Bond Forecasters after correctly predicting where the benchmark Treasury would end the year.

I spoke with him, as you can read below, about the prospects for an accelerating economy this year, interest-rate cuts that may come later than forecast by other economists and the best place to put money this year.

Chuck Jaffe: Joe Brusuelas, it’s great to have you back.

Joe Brusuelas: Good to be here, Chuck.

CJ: I’m glad we get a chance to look ahead because, as I’ve said many times: Everybody’s forecasts for 2022  were pretty much wrong because the market was so much worse than people expected and everybody’s forecasts for 2023 were pretty much wrong because everybody felt there’d be one or two different events — a recession or a landing — and none of that stuff really happened.

So is any of that stuff going to happen this year?

JB: I think the economy is in a very strong spot right now. If you just look at where growth was at the end of the third quarter, it was up 2.9% on a year-ago basis, it advanced 4.9% in the quarter.

And we’ve just got an undeniably strong labor market, which underscores the strong floor that supports all of the economic activity that’s going on. Take a look at where the American consumer is, right? Employment’s 3.7%. We added 2.7 million jobs in 2023. It’s very easy to find a job these days, just over two months of unemployment and you’ve got a new job. Holiday spending — it looks like it was up just under 5.5%. Remember those predictions, the dire ones, to start the fourth quarter of 2023 that debt was going to overwhelm consumers, we were gonna have the worst Christmas on record. None of that materialized.

Right now, you’re going to see the economy slow in terms of overall growth back toward the long-run trend. It’s about 1.8%. You’re going to have a holiday hangover in the first quarter with respect to spending. And then you’re going to see a reacceleration in the economy. And we’re going to do just fine. In other words, it is a soft landing. Then we’ll see what happens with policy, we’ll see what happens with Federal Reserve rate cuts to see if we really do get a mid-cycle liftoff later this year.

CJ: The market has taken into account as many as six Fed rate cuts this year — does that seem likely to you?

JB: So to answer the question directly, no, it does not seem likely. I think the market’s a bit out over its skis with respect to the timing. March is the first rate cut. We disagree. We think that’s June at the earliest. And then the order of magnitude, how many rate cuts? The market’s priced in six. We think four at best, and that’s four 25-basis-point rate cuts starting around mid-year simply because the policy rate is far too restrictive given the downward trend in overall inflation. That is, it’s not the price level that’s falling, it’s the growth in inflation that’s slowing.

We think the Fed has been quite clear in the fact that they plan to make at least three rate cuts — that’s in their forecast. And recently they’ve been talking about creating the policy conditions whereby they can slow the runoff on the Fed’s balance sheet, what the market participants call quantitative tightening, which would really bolster liquidity when that happens, whether it’s later this year or in early 2025. Those are all bullish for the market. I think they’re bullish for the economy and bullish for households. And so that’s quite constructive and encouraging when one takes a step back and looks at it.

CJ: Bonds have been through two tumultuous years. And even if it’s four or even two rate cuts, well, that shakes up the bond market. So what is your expectation on bonds?

JB: When we look at where the fixed-income market is, I look at the 10-year, that’s the global benchmark, as well as the U.S. benchmark. As we talk, it’s sitting right around 4%. Now I think that’s a little overbought, given the level of supply that’s coming to market, that’s Treasury issuance. And given the rate at which I think the economy is going to grow this year and the fundamental strength of the U.S. household, we think 10-year target would be 4.25%. We think it’s going to trade between 4% and 4.5% for much of the year. But we think most of the action in the fixed-income market is going to be at the front of the curve. Between two years and five years, and right now what’s interesting is you already have a positive upward sloping two- to five-year rate curve.

That’s exactly what you want to see in the first step toward normalization. When I mean normalization — you and I have been talking, oh my gosh, I’m going to age myself now — we’re clearly past the zero interest rate era. That’s closed.

And I do think the stage is set for late this year, early next year. We get a disinversion of the overall bond curve from two to 30. And we do see a positive upward sloping curve along that entire maturity spectrum. OK, let me put that in English. What that means is there’s going to be a price attached to money. The effective end of zero interest rates, free money, that’s gone.

CJ: What adjustments are you therefore suggesting? Given that you don’t think we’re going to get as many rate cuts as what’s priced in, do you start lengthening maturities more quickly or do you let this ride and wait?

JB: Right now what you want is you have to accept the fact that we’ve had a regime change in the market. Two, you need to begin thinking more prudently about your risk management. Three, one has to come to grips with the level of Treasury issuance that’s going to characterize the narrative here this year and next. Then you can begin thinking about, well, how do I manage my duration risk?

How do I lengthen out that maturity that we’re going to see right now in the short term? I think everybody’s in the wait-and-see mode. My sense, though, is in terms of the economy and the rate forecast, smart money will begin to move, likely soon. Then the signal, because you always have to differentiate between noise and signal, will be given and then you’ll see the broader move. Now, anytime the Fed reaches its rate cycle, you typically see asset markets adjust. The equity market clearly adjusted.

Historically, when the Fed reaches that peak, you see a 20% to 30% increase in overall valuations. Well, through the end of last year, I think the S&P 500 was up over 24%. So we got that move. I still think there’s a little bit there.

My sense is with respect to fixed-income, there’s value to be had at the front of the curve for more sophisticated investors. It’s not something retail investors are likely to be able to play on their own. And it’s going to be a little bit more time before we have a real sense of where we’re going to be longer term on rates.

The other thing, Chuck, is that we’re in a period now where we’re going to have to deal with some of the echoes from the pandemic era, precisely the impact of those low rates in 2020 that characterized the pricing of risk and issuance of bonds, especially corporate bonds.

In 2025, that vintage 2020 is all going to have to be rolled over, albeit at much higher rates. Let me give you an example, and I think some of your listeners will really get this: Corporate bonds issued at $800 million at 5% back in 2020 are going to need to be rolled over. But they’re not going to be able to get that same term on those quantities.

So you’re thinking, well, probably 500 million at 8%. Therefore, you’re going to see private credit step in. Private equity is going to step in. And we’ll start to see that turn later this year. But that repricing of risk and that rollover risk will define, I think, 2025. Now, how much is coming? I think it’s between $3 and $3.5 trillion. And that’s the publicly listed stuff that we know.

And of course, this year, we’re going to start to see some of the churning commercial real estate. So I think that really lays out both the risk and the rewards around what we see in terms of the economy, rates and the corporate sector.

CJ: What about domestic versus international? The rest of the world is not entirely in sync with the U.S. and where things are. So is there much benefit to going outside?

JB: So the U.S. is the leader, not the laggard this year. We still have some time before I think you see an improvement in the global economy. You’ll see some opportunities. I mean, clearly India is going to be the major or the leader among the major economies. There’s significant risk, I think, still in China because they’ve got to work through their debt and the leveraging crisis. But that’s another topic for another day.

And I think the rate differentials are still significant enough that one has to prudently manage risk around emerging markets right now. I think there’s still some risk there. We’re not through that yet. But again, smart money will begin to move, I think, really, in the late second quarter. And then we’ll see what happens from there.

CJ: How much do you worry about geopolitical risk and politics in an election year messing things up?

JB: We clearly watch that. It’s two levels. One is what we see every day. You know, the Middle East, the war in Ukraine, you can’t do much about that. That’s the level of idiosyncratic risk. Idiosyncratic risk, that’s difficult to quantify. And of course, the political violence here at home that we see. I’m not worried about fixed business investment drying up in front of the election. That’s just not going to happen. But one does worry about a contested election on the other side, given the history, recent history and the memories of Jan. 6, 2021.

CJ: Joe, I have more questions. Unfortunately, I don’t have more time.

JB: You got it, Chuck. Thank you. Glad to do it.

Chuck Jaffe is a contributor at Equities and the host of “Money Life.”

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