The market is sceptical on the right time for rate cuts to keep growth and avoid recession, and whether inflation is under control remains the big question. If not, how should investors proceed?
These were the tricky issues put to panellists at the Insurance Investor Live | North America event in December last year in New York, which is now featured in the Insurance Asset Management North America 2024 report.
Featured in the discussion were Brian Butchko, Senior Vice President and Head of Global Portfolio Management, Reinsurance Group of America, as well as representatives from PPM America and Swiss Re, with Stephanie Thomes, Senior Insurance Investment Consultant, Mercer moderating.
The panel discussion began with Thomes quoting a 5 December 2023 article from Bloomberg, “Did Markets Go Too Far, Too Fast Is Debate to Dominate December” by Garfield Reynolds and Rita Nazareth. It reads: “December’s whipsaw opening shows investors may be concerned that November’s [2023] epic rallies went too far, too fast in anticipating a near perfect soft landing for the economy. Wall Street kicked off this week with losses for stocks and bonds in a sign that traders’ aggressive pricing for early rapid Fed reserve rate cuts in 2024 may have overshot.”
Thomes pitched the question of, taking these factors into account, where should stakeholders start looking for the US Federal Reserve (Fed) to start cutting US interest rates in 2024.
At the moment, no rate cut has happened. In mid-March, CNBC predicted that the Fed “will likely cut interest rates by a cumulative 0.75 percentage points to 1 point in 2024”, with the idea of creating a “soft landing”.
A faster rate cut has been hampered by strong economic growth in the US. The Q4 2023 growth rate was 3.2%.
“The economy has defied dire warnings of a recession after the Federal Reserve aggressively raised interest rates to tame inflation, thanks to a tight labour market that is keeping wages elevated and supporting consumer spending,” said Reuters in its summary of the situation.
Last year, most thought the US would see receding interest rates for the election year, but the Fed made few moves at the end of 2023. “Barring any new 'risk premium' event in the energy sector, we'd share the view that the steady rate of disinflation in the US will continue through 2024, a continuation of the steady progress made in this area throughout 2023,” said Joe Tuckey, Argentex’s Head of FX Analysis, to Insurance Investor in December.
"They probably feel they have inflation under control, so why rush it?"
“Inflation is falling faster than the Fed had thought,” he added.
Read more below to see more thoughts as well as his views on commercial real estate (CRE) and the fixed income situation.
Brian Butchko: I am sceptical about rate cuts, and I know that this isn’t the market consensus, but the market thought that we would be in a recession right now and that rates would be cut a month ago. [We need to keep in mind] the Federal Reserve’s (Fed) mindset, which is an important aspect. They probably feel they have inflation under control, so why rush it?
Brian: Some asset classes only work in a low-rate environment – specifically some segments of CRE office lending. In a lot of cases, workouts are going on and we are pulling back in that area, but otherwise, I do feel that there are not as many asset classes as you would think have changed.
"We feel that there are not too many places that are off-limits for us right now."
We do see an environment with higher yield. Going into this environment, most companies did have strong balance sheets and were able to handle the higher interest expense. We feel that there are not too many places that are off-limits for us right now.
Brian: In retail, there hasn’t been much built in the US in the past ten years, which means that leasing activity has been favourable, especially in the Sunbelt. We have been lending against these assets and the industrial sector has been an unbelievable performer lately, so we see opportunities there as well. I would also mention multifamily, which continues in many places not to be overbuilt, and we have been happy with the performance of those assets.
In general, other than office, most of our real estate portfolio is holding up well, and we expect to see it continue to do so. It’s the office sector that we need to deal with.
Brian: We have a big commercial mortgage loan lending, which is called Recap, and we have field offices spread throughout the country. We are the only lender in the capital stack, so our average loan balance is small given the size of our balance sheet. We are seeing that many of our clients or borrowers used to use the local or regional bank and are just not interested right now; they have other things that they are focused on.
"Spreads are significantly better than investment grade corporate bonds
by 100-150 basis points for the same capital."
It is still competitive, as they can find other people willing to lend. Spreads are significantly better than investment grade corporate bonds by 100-150 basis points for the same capital, so we have been able to pick up some spread but maybe not as high as we thought because if they get one or two other lenders, it gets competitive and is better than what the regional banks would have done. But it’s still an orderly market.
