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The great debate

Insanity, or savvy pre-emptive action. That seems to be great debate with regard to the Federal Reserve’s recent decision to push interest rates 25 basis points lower at its last Federal Open Market Committee (FOMC). So what’s behind the rancor? 

The chief threat to the current economic run seems to center around trade turmoil, which many believe is already acting as a drag on economic growth, both globally and domestically. Although it seemed progress was being made in the U.S. – China trade spat, flashbacks to elevated volatility rematerialized recently. The growing possibility of supply chain disruptions and the economic impact of higher costs has roiled markets. Also troubling were separate threats of heavy tariffs on Mexican goods, as well as uncertainties surrounding the appointment of a new U.K. Prime Minister, which further complicates Brexit negotiations with European leaders. And finally, let’s not forget the Italian fiscal situation, sudden political changes in Argentina, and renewed U.S.–Iranian tension over its nuclear program. All these global undercurrents have weighed heavily on markets. The FOMC (and other global central banks) took notice and lowered the federal funds rate at the end of July.

While the domestic economy turned in enviable metrics early in the year growing at an annualized rate of 3.1% during the first quarter, growth in the second quarter seems to have slowed to an estimated 2.1%. Consumption looks to have strengthened, led by elevated consumer sentiment and increased spending. All the while, the impressive job-creation streak continues unabated, with unemployment hovering near record lows at 3.7% and with solid payroll and wage growth. Given these robust statistics, it’s no surprise why some pundits were questioning the need for this “insurance” rate cut.  It’s our belief that the federal reserve never would have gotten rates to 2.5% in the first place if it weren’t for the fiscal stimulus of tax cuts. With the marginal effects of the stimulus having abated, the inverted yield curve is signaling over-tightening of monetary policy, and the Federal Reserve will now be forced to move quickly back to 1.50% in our view.

Questioning the merits of a rate cut might make for spirited debate, but it’s largely irrelevant. More important is how investors may wish to tilt fixed income portfolios (within their respective strategies). Given the current economic backdrop and the fact that more easing may be on the way in this era of elevated trade tensions, here are three actions worth considering:

1. In total return strategies, the significant shift lower in rates and flatter yield curve argues for a reduced allocation to high-yield corporate bonds. While domestic fundamentals appear strong, we are somewhat cautious with only one-third of our allowable maximum exposure.

2. For low-duration strategies, an overweight allocation to fixed rate corporate bonds and securitized sectors (namely agency mortgage-backed, asset-backed, and commercial mortgage backed securities) could continue to provide a tailwind. Floating rate securities are likely to underperform in the coming rate-cutting cycle.

3. For municipal strategies, a focus on quality, coupled with an underweight position on the one-to-five-year part of the curve, may boost performance if the municipal curve continues to follow the Treasury curve flatter.

The U.S. economy has shown resilience in the face of slower global growth, and we expect that to continue if the Federal Reserve lowers rates appropriately. Geopolitical risks and prolonged trade uncertainties could impact this view, and it seems with the most recent Fed action that global central banks stand ready to act (both with lower rates and larger balance sheets) to support a more robust global growth environment. Of course, investors need to stay alert as the situation is dynamic, and suggestions for fixed income repositioning could change abruptly. After all, remember “the pivot.”


Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens. 

Bond ratings are measured on a scale that generally ranges from Aaa (highest) to C (lowest).

Victory Capital, Inc. is a Registered Investment Advisor. The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. Any opinions, projections or recommendations in this report are subject to change without notice and are not intended as individual investment advice. Not to be used as legal or tax advice. 

©2019 Victory Capital Management Inc.
Consider the investment objectives, risks, charges and expenses of the funds carefully before investing. Download a prospectus or summary prospectus, if available, containing this and other important information for USAA Mutual Funds from, for Victory mutual funds from, or for VictoryShares and VictoryShares USAA ETFs from Read it carefully before investing.

Investments involve risk including possible loss of principal. The value of the equity securities in which the fund invest may decline in response to developments affecting individual companies and/or general economic conditions. Dividends are never guaranteed. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty, and greater volatility. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. You may lose money by investing. There are no guarantees the funds will achieve their investment objectives and strategies may be unsuccessful.

Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

ETFs have the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited and often commissions are charged on each trade, and ETFs may trade at a premium or discount to their net asset value. There can be no assurance that an active trading market for shares of an ETFs will develop or be maintained. The ETFs are not actively managed and may be affected by a general decline in market segments related to the Indexes. The ETFs invest in securities included in, the Index, regardless of their investment merits. The performance of the ETFs may diverge from that of the Indexes. 

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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Victory Capital means Victory Capital Management Inc., the investment manager of the USAA Mutual Funds and VictoryShares USAA ETFs. Victory Mutual Funds and USAA Mutual Funds are distributed by Victory Capital Advisers, Inc. (VCA). VictoryShares ETFs and VictoryShares USAA ETFs are distributed by Foreside Fund Services, LLC (Foreside). VCA and Foreside are members of FINRA and SIPC. Victory Capital Management Inc. (VCM) is the investment adviser to the Victory Mutual Funds, USAA Mutual Funds, VictoryShares ETFs, and VictoryShares USAA ETFs. VCA and VCM are not affiliated with Foreside. USAA is not affiliated with Foreside, VCM, or VCA. USAA and the USAA logos are registered trademarks and the USAA Mutual Funds and USAA Investments logos are trademarks of United Services Automobile Association and are being used by Victory Capital and its affiliates under license.

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