Have liquidity at the ready to evolve your portfolio construction, says JPMorgan's Oksana Aronov

Key Concepts

• Market volatility and uncertainty
• Treasury market range and potential movement
• Shifting economic narratives (recession, soft landing, stagflation)
• Federal Reserve's (Fed) dilemma: addressing growth vs. inflation
• Limited Fed intervention due to inflation
• Evolving fixed income strategies: tactical approaches and liquidity
• Importance of entry point in bond investments
• Credit risk and increasing defaults outside of a recession

Market Outlook and Uncertainty

Oksana Aronoff, Head of Market Strategy for Alternative Fixed Income at J.P. Morgan Asset Management, discusses the current market environment, emphasizing ongoing uncertainty. She anticipates continued market "chop" in both treasuries and equities. Treasuries are expected to fluctuate within a range, potentially moving back into the "high fours" (likely referring to yields in the high 4% range) due to upcoming policy changes.

Shifting Economic Narratives and Stagflation Risk

Aronoff highlights the evolving economic narrative, shifting from recession fears to a "soft landing" scenario, and now potentially towards a slowdown with higher inflation, raising the possibility of stagflation. She stresses the importance of being prepared for various scenarios and not dismissing any possibilities.

The Federal Reserve's Dilemma

The Fed faces a difficult situation, caught "between a rock and a hard place." If a slowdown occurs alongside elevated inflation, the Fed must decide whether to cut rates to stimulate growth or maintain or even raise rates to combat inflation. Aronoff suggests the Fed may have initiated the cutting cycle prematurely.

Limited Fed Intervention

Aronoff believes the days of the Fed "swooping in to the rescue" with significant rate cuts during economic downturns are largely over. With inflation remaining persistent, the Fed's ability to provide substantial support is limited. She notes that tariffs implemented by the administration could add roughly 0.5% to the current inflation rate. The Fed is more constrained by the inflation environment now compared to 2018 when similar policies were implemented, as inflation then had a "one handle" (likely referring to inflation in the 1% range) compared to the current "three handle" (inflation in the 3% range).

Evolving Fixed Income Strategies

Aronoff argues for an evolution in fixed income strategies. While equity investors are accustomed to market volatility and potential losses, fixed income investors rely on stability and wealth preservation. She advocates for a more tactical approach in fixed income investing. For example, her firm was a buyer of 2-year treasuries when yields reached 5%, but not necessarily at the current level of around 4%. She emphasizes the importance of having "liquidity at the ready" to capitalize on opportunities.

Importance of Entry Point and Credit Risk

Aronoff cautions that the price returns bond investors experienced in the past 10-12 years since the financial crisis are unlikely to continue. The price at which an investment is made is crucial. She also highlights the increasing credit risk in portfolios, noting an "unprecedented amount of defaults for a non-recession part of the cycle." While these defaults are not headline-grabbing, they involve smaller companies. The number of defaults is high, but the dollar value is lower because smaller players are struggling. These defaults serve as "warning signs."

Synthesis/Conclusion

The key takeaways are that market uncertainty persists, the Fed's ability to intervene is constrained by inflation, and fixed income investors need to adopt more tactical strategies, focusing on entry points and managing credit risk. The traditional approach to fixed income investing, relying on price appreciation, may no longer be viable in the current environment.