Monetary Policy Changes

This time Is different We don't often say that about the Fed, but after yesterday's FOMC meeting, we think it may actually be true. In fact, we believe yesterday's meeting ushered in a new era of monetary policy in the United States.    For the better part of two decades, monetary policy has followed a familiar playbook: extensive forward guidance, frequent communication, data dependence and the  Federal Funds rate as the primary policy tool. While leadership has changed, the broader framework has remained remarkably consistent.   What we heard yesterday suggests the possibility of a meaningful evolution.   We believe the Fed may be moving toward a framework that places less emphasis on signaling every move in advance and more emphasis on assessing where inflation, employment and broader economic conditions are heading. In a world of real-time data and increasingly sophisticated analytics, that could prove to be a healthier and more effective approach.   We also continue to hear indications that the policy toolkit could broaden beyond the overnight policy rate, with greater consideration of balance sheet policy, liquidity conditions, money supply dynamics and longer-term interest rates.   Importantly, change does not automatically mean more volatility. A broader set of tools and a more forward-looking approach could ultimately increase confidence in policy outcomes rather than diminish it.   For investors, the near-term message remains straightforward: inflation is still above target and remains the Fed's primary focus. While rate hikes are far from certain, they remain a possibility that markets need to respect.   That's one reason we continue to favor income-oriented fixed income opportunities over pure interest-rate expressions. And when markets overreact to uncertainty around policy change, we think there may be opportunities to sell volatility rather than buy it.   This time may indeed be different, and it will be fascinating to watch how this evolution in monetary policy unfolds. The real question is whether less signaling creates more uncertainty, or ultimately more confidence in the Fed's ability to achieve its objectives.

The Fed has taken a significant step by officially initiating its cutting cycle, which holds profound implications for the financial world. ⚠️The #FOMC has cut the FFR by 50 Basis Points to a 4.75%-5% Range. ⚠️The latest projection of the Neutral Rate, R*, came in at 2.8% versus the previous estimation of 2.9% A cutting cycle might affect other central banks' stance on monetary policy because the US Dollar could devalue considerably going into 2025, making exports from other countries like Japan more expensive. For the past two weeks, business media has made a huge story out of a 25—or 50-basis point cut, but in my opinion, today's decision on the magnitude of the cut is meaningless. Financial conditions have eased considerably since July, so it should not be a surprise that the US economy might have already started to re-accelerate. The Atlanta Fed GDPNow is flashing a Real Growth Rate of 3% for the US Economy. If that materializes, it would mean that the US #Economy is already running 1% above its potential. Why financial conditions have already started to ease? Here are some examples: ✍️Mortgage Rates decreased from 7% in July to 6.15% today ✍️The 2-Year Yield decreased from 4.75% in July to 3.63% today ✍️The 5-Year Yield decreased from 4.06% in July to 3.47% today ✍️Housing Starts have picked up momentum What market participants have priced out is a resurgence of inflation during 2025. That scenario is entirely possible if the Dollar Index drops below 100. A cheaper dollar will make commodities and import prices more expensive for the US consumer, and a reduction in real income could squeeze even more of the low to middle class into the USA. Considering the decrease in US Treasuries for the past two months, I find US Government Bonds expensive across the yield curve at these levels. I think R* is well above what the Fed estimates because of factors like de-globalization, the reshoring of strategic industries, and increased protectionism. The terminal rate post-pandemic is between 3.5% and 4%, in my opinion, and that is where I think this cutting cycle will end. If I am proven right, bond investors must reprice government bond yields higher. How do we play a potential increase in inflation in a no-landing scenario? I tilted my portfolio as I outline here below: 👉Tilt the portfolio to over-weight energy and miners. 👉Have a marginal exposure to Gold and Silver. 👉Favor TIPs over US Treasuries 👉Increase allocation to US Value Stocks and International Stocks. 👉Lock-In US Investment Grade Credit at the belly of the yield curve where we can still get 4.8% to 5% yields, especially on issues at the Single-A Rating Enjoy the ride! #Finance #InterestRates #Economy #Investing

If long-end bond yields spiral out of control, the Fed could start injecting liquidity again: a step-by-step guide of how it works. When a few weeks ago 30-year bond yields briefly flirted with the 5% level, the Fed's Collins released an interview stating that ''the Fed is absolutely ready to stabilize markets''. To stabilize the bond market, they would ''inject liquidity'' through operations like the LSAP - Large Scale Asset Purchase or QE. Central Banks create bank reserves when they perform such operations. Bank reserves are often referred to as ''Liquidity''. When Central Banks engage in liquidity creation, they do that in the hope that it activates the so-called Portfolio Rebalancing Effect. To understand this, let’s start from what QE does to the balance sheet of a commercial bank - take a look at the chart below. Following the GFC, regulators forced banks to own more HQLA (high quality liquid assets) to meet depositor outflows. Bank reserves and bonds qualify as ''HQLA'' as they are liquid enough to be converted in cash to meet potential outflows quickly. But banks are not indifferent between owning bank reserves and bonds, and especially if the amount of reserves grows dramatically as a result of QE. Bank reserves are a zero-duration and low-yielding instrument which can be suboptimal to own in big sizes especially if compared with bonds which offer higher returns and duration hedging properties. And this is when the Portfolio Rebalancing Effect kicks in. Once QE starts, Central Banks take away bonds and inject new reserves in the banking system. Loaded with suboptimal reserves, banks will try to switch back the composition of their portfolios towards more bonds. They will bid up safer bonds first, and bid up riskier bonds later when the hunt for returns intensifies. This will kick in a virtuous cycle of low volatility and a hunt for riskier assets: the Portfolio Rebalancing Effect in action. Summarizing: 1️⃣Central Banks expand their balance sheet and purchase bonds 2️⃣Commercial Banks are on the receiving end of QE, and hence their portfolio composition tilts towards more reserves, and less bonds; 3️⃣But reserves are sub-optimal to own compared to regulatory-friendly bonds, and hence they look to rebalance their portfolios; 4️⃣They start buying the very same bonds QE is buying, hence suppressing volatility further and compressing credit spreads; 5️⃣Asset allocators and investors across the world are more and more encouraged to take additional risks in their portfolio, supporting the flow of credit and capital. Does the Portfolio Rebalancing Effect make sense to you? 👉 If you enjoyed this post, follow me (Alfonso Peccatiello) to make sure you don't miss my daily dose of macro analysis.

Private Thoughts From My Desk ……………. #33 𝐓𝐚𝐫𝐢𝐟𝐟𝐬 & 𝐔𝐧𝐜𝐞𝐫𝐭𝐚𝐢𝐧𝐭𝐲: 𝐖𝐡𝐚𝐭 𝐈𝐭 𝐌𝐞𝐚𝐧𝐬 𝐟𝐨𝐫 𝐏𝐄 𝐑𝐢𝐠𝐡𝐭 𝐍𝐨𝐰 After five years of what I can only describe as "unique disruptions"—a global pandemic, unprecedented inflation, interest rate shocks—we now face yet another: a new wave of tariffs. For private equity, the impact of these policy moves isn’t just about the numbers—it’s about the uncertainty they inject into long-term models. Private equity lives and dies by its ability to predict the future—five years at a time, with leverage. So when policy shifts like these arrive without clear direction or a timeline, deal pipelines stall. It’s not that the tariffs themselves are necessarily fatal—it’s that no one knows what game we’re playing, or how the rules might change again next quarter. We entered 2025 with momentum. Intermediaries were busy, due diligence was in high gear, portfolio companies were readying for exit. But in February, the “T word” started surfacing. Tariffs are just another word for uncertainty—what I call the dreaded “U word” in private equity—and everything slowed. Activity now reflects what we’re hearing every day: it’s hard to make long-term bets when you don’t know what to model in the short term. For LPs, the liquidity crunch is especially acute. Liquidity is at levels we haven’t seen since the Great Recession. Many LPs are rebalancing through secondaries; some are exploring NAV loans and other creative strategies. The ones with dry powder—sovereign wealth funds, select family offices—see dislocation as opportunity. But for most, frustration is mounting. Fundraising is feeling the pinch, see the chart below for buyout fundraising trends. Exit activity is a leading indicator—and right now, that indicator is flashing yellow. Fundraising was always going to be challenged in 2025. Now, recovery may be deferred even further. So what can GPs do? It’s back to basics (again) with portfolio companies: secure the balance sheet, conserve cash, and avoid covenant or financing issues in the near term. There’s also renewed urgency to get EBITDA up—quickly—through pricing, cost reduction, and working capital optimization. Anything that opens the door to a liquidity event in the near term. This is also a time for firms to solidify their long-term strategy. Some are asking whether it’s time to double down on what they do best and exit non-core strategies. Consolidation is no longer theoretical—it’s a daily conversation, especially for firms caught in the increasingly challenging middle market. This isn’t a crisis. But it is a moment of reckoning. In a market defined by scarcer capital, talent, and investment opportunities—not everyone wins. Knowing what you do best, doubling down on it, and charting a clear path forward for your firm are more essential than ever. #privateequity #privatemarkets #privatethoughtsfrommydesk

RBI did 3 important things in the policy yesterday of which most only understand about the rate cut, let me explain the other 2 interesting points, (1) RBI announced 1L cr of OMO - OMO stands for open market operations in which RBI is going to buy back existing government bonds in which banks have invested. Banks have a mandate to invest in government bonds. So when RBI does OMO of 1L cr, essentially they buy back bonds & give 1L cr to the banks. In short more liquidity for the banks (2) RBI announced a $5B Buy/Sell USD/INR swap for 3 years - In this RBI will buy $5B of USD from the bank & give the bank equivalent rupees ~45,000 cr with a promise that after 3 years they will reverse it, give them the $ back & take rupee back from them. This also increases another $5B means around 45,000 cr of rupee liquidity with the banks. So rate cut, OMO & currency swap all will increase liquidity with the bank & the hope is that the banks will reduce rates, lend more & hence positive for the markets!

We’ve updated our #rate forecasts post-election, based on three main assumptions: 1) The #Fed will continue cutting rates, but may proceed more cautiously and maintain some optionality along the way; 2) The economy will continue to grow around trend near term; 3) A Republican sweep raises the prospects of fiscal expansion, which increases growth and inflation expectations. We still believe the direction of travel for interest rates is lower as any policy changes will likely take time to be finalized and implemented, the labor market continues to loosen, and the terminal rate has already repriced higher. But we now see the 10-year US Treasury yield trending towards 4% by June 2025, up from our previous forecast of 3.5%. Read more below.

As illustrated by this Bloomberg chart, the price shock emanating from the Middle East War has shifted market expectations toward a "higher-for-longer" rate environment across nearly all systemically important central banks. (The outlier remains the Bank of Japan, which continues to inhabit its own paradigm—though less so recently. However, identifying the changed rate trajectory is merely the opening act of the analysis.) The current situation represents more than a simple price shock; it also involves a "second-round" adverse demand shock. Beyond these immediate economic effects, there is the lingering risk of spillovers into financial instability. All of this underscores the uncertain outlook: central banks will be navigating a series of judgments which, I suspect, will likely (or should) be adjudicated by a single, sobering question: "Which is the least unrecoverable mistake we can make?" The answer to this question is less complicated for single mandate central banks, such as the BoE and ECB, than it is for the dual-mandate Fed. #economy #markets #centralbanks

So impressed with the work the team has been doing on our Guide to Alternatives - with the 3Q version hot off the presses. These are my favorite slides this quarter to talk about 3 hot topics: 1. #FedRateCutsAreBack, who benefits? It's not just public stocks and bonds. Many alternative assets fund themselves through floating rate debt. Lower Fed rates = lower SOFR = lower borrowing costs for businesses and investors financing themselves through direct lending. Issuance to fund #PrivateEquity deals makes up the majority of direct lending. 2. Is #CapitalMarketsActivityBack too? Lower borrowing costs + valuation support + less macro uncertainty = recent rebound in M&A and IPOs. After a very slow 3 years (and disappointing 1Q), capital markets activity is back to 2021 levels so far 1H25. Private Equity wheel is turning again: financing + purchases + improvements + sale to another company (or another PE fund) or public market exit = distributions to investors again. 3. #WhatAboutSmallCaps? Small cap stocks have been outperforming large caps by 4%pts this quarter. We think that's short-lived given a soggy economy and margin pressure. More interesting place to look for accelerated growth is private markets. #PrivateEquityIsTheNewSmallCap as our Global Alternatives Strategist Aaron Mulvihill, CFA likes to say. 84% of companies with over $100mn in revenue are now private. Check out our full 3Q Guide to Alternatives through the link in comments. Aaron Mulvihill, CFA Grant Papa Aaron Hussein Kerry Craig, CFA Adrian Wong, ASA

There has been a lot of comment on the changes in the exchange rate regime announced on 31st December. Most of the comments have read far too much into these changes. There are a few important things that need to be understood. The first point to note is that nothing fundamental has changed about the Pula Basket. Second, tweaking the parameters of the Pula Basket happens every year end (and occasionally mid-year). The (small) change in the weights is not a big deal, and has happened regularly in the past. The increase in the ZAR weight from 45% to 50% is nothing exceptional (in our view it was long overdue as the weight gone too far in the direction of the USD/SDR). Third, there is no devaluation involved in these changes - other than the downward crawl of 1.51% a year, but this has been in place for several years, and is not changed. The increase in the ZAR weight is not a devaluation, and indeed the change in the weights has no immediate impact on the exchange rate. It will just influence the course of the BWP over a period of time against individual currencies (but not its overall value). It will be a bit more stable against the ZAR, which is positive as the BWP/ZAR exchange rate is the most important one for most firms in the country. The biggest change, in our view, is the widening of the BoB's buy/sell trading margins, which almost nobody has commented on. This may be seen as a first step in a long-term process of making the exchange rate more flexible and more responsive to market forces (under the Pula Basket mechanism the overall value of the BWP is not influenced at all by market forces, and this is probably not sustainable in the long term).

🔴 In 2022, the interest rate was 4.5%, compared to 0% at the beginning of 2021. If you had known in 2021 that rates would rise to nearly 5%, would you have beaten the stock market? The answer is: most probably NOT. Why? Because conventional economics taught in business schools says that when interest rates rise, money flows to safer assets like government bonds— known as "flight to safety." Since money has to come from somewhere, it typically comes out of risky assets like the stock market. That means equity prices should fall sharply, with the riskiest assets—like tech stocks—falling the most. So if you had followed that logic, what would your portfolio have looked like? It would have been filled with government bonds, very limited equity exposure (expecting a drop), and almost no allocation to tech stocks. Now, in mid-2025, how would that portfolio have performed? The answer: Extremely Poor. Your so-called risk-free asset (government bonds) would have lost over 25% in mark-to-market terms. Your equity portion would have performed better, but not significantly, since your allocation was too small. So what did the Business School model get wrong? The mistake was focusing on the wrong indicator at the wrong time. When your currency starts to devalue significantly—due to excessive government printing—traditional monetary policy tools like interest rates don’t work. Even if they do work, the impact is small. That’s called fiscal dominance, when fiscal policy overpowers monetary policy. Yes, the Fed raised rates in the most aggressive way in 40 years, but it didn’t stop the flow of money into markets. Since 2020, the U.S. government has injected over $10 trillion into the economy—creating about 33% of the total dollar supply in just 5 years. Interest rates affect the government less because it has the money printer. In simple terms, that's currency debasement. When debasement occurs, scarce assets outperform because they can't be printed like money. That’s why equities and risky assets soared while so-called risk-free assets lost value. If you had simply invested in Meta at the end of 2022, your portfolio would have grown over 700% by now. The story is similar for other large-cap tech stocks. Currency debasement lifted equity markets. This year alone, Venezuela’s stock market returned over 300%—not driven by fundamentals, but by currency debasement. Warren Buffett is a fundamental investor. As everything seems overvalued to him, he sold off and is now sitting on a $330 billion cash pile. But he doesn’t realize that the market is no longer driven by fundamentals—it’s driven by liquidity, printing, and debasement. Fundamentals—markets driven by earnings—were severely damaged in 2008 and effectively died with the 2020 COVID stimulus. This year, Buffett will end his legendary career—and with it, the era of “value investing.” 👇