Money in Motion: Playing the Trade with More Clarity: Rate Cuts

Key Takeaways

The news of President Biden dropping out of the presidential race has no doubt created a whole new layer of uncertainty in the market backdrop. Interestingly, the spotlight is always on who is going to become President, but in reality, it’s not that cut and dried. Indeed, equally important is which party is going to control the two chambers of Congress. With this much uncertainty hovering over the investment landscape, we recommend focusing on the issue that arguably has more clarity at this point: Fed rate cuts.

In this first of a series of Money in Motion blog posts, I want to discuss how investors should be looking to play rate cuts in their fixed income portfolios. While getting to the first rate cut has not been a smooth ride (and we’re not even officially there yet), it does appear that Powell & Co. are getting more confident in such an easing move occurring at the September Federal Open Market meeting.

However, what this rate cut cycle will ultimately look like is also an important consideration. At this point, the Fed seems to be gravitating toward a policy that remains restrictive, but not as restrictive as what is currently in place. In other words, inflation has made enough progress toward their 2% goal, so why not take the foot off the brake pedal a bit?

Whether or not this potential easing cycle takes on more momentum will depend a great deal on the labor market setting. If the unemployment rate holds steady to modestly higher, then rate cuts will likely not be that aggressive. Conversely, a visible weakening in labor market conditions combined with continued disinflation will no doubt lead to a more active rate-cutting policy.

So, how does an investor prepare for these possible monetary policy scenarios? With the time-tested barbell strategy. By using this approach, investors are afforded flexibility to begin adding duration in a deliberate fashion while still taking advantage of the income available with less volatility in the ultra-short/short portion of the inverted yield curve.

The WisdomTree in-house barbell strategy uses our Floating Rate Treasury Fund (USFR) for the ultra-short/short position and our Yield Enhanced U.S. Aggregate Bond Fund (AGGY) for the duration counterweight. I recently blogged about the “still” inverted Treasury (UST) yield curve and how the 3-month/10-Year differential remains well into negative territory to the tune of over -110 basis points, as of this writing. With UST Floating Rate Notes being referenced to the 3-month weekly T-bill auction, one can take advantage of what the negative yield curve will more than likely continue to offer even when rate cuts begin. The “adding duration” aspect is designed to not only begin locking in yield outside of shorter-dated maturities, but also offers the ability to try and take part in a bond market rally if rates reverse course and fall again.

For investors who would prefer more of a “pure” rate play and focus only on U.S. government securities in their barbell, we recommend considering a solution in our Treasury suite of Funds; the WisdomTree 7-10 Year Laddered Treasury Fund (USIN). This Fund would represent the “adding duration” aspect to the barbell and serve as the tool to lock in yield while potentially benefitting from a decline in rates further out on the yield curve.

Conclusion

With uncertainty surrounding the investment landscape and Fed policy becoming front and center in the discussion as summer progresses, the barbell approach provides investors with a time-tested, flexible strategy to navigate the road ahead without making an outright rate call.