June 26, 2019 - “Fed Day” has come and gone. No rate cut for now, but Federal Reserve Chairman Jerome Powell indeed scrapped his longstanding “patience” speak in favor of more of his “willingness to act as appropriate” talking points. While little was promised but readiness, there was also no push back against widespread market expectations for cuts ahead.

All of this is seemingly a prelude to the Fed’s first rate cut in more than a decade, perhaps as soon as next month. The futures markets are pricing in a near certainty of a cut in July, while the Fed’s own “dot plot” projection shows that its board members are in fact relatively mixed on whether or not cuts actually occur this year.

Whatever is the exact timing of things, it seems clear that the likely path of short-term rates is to move lower in the year ahead. What that portends for managers of a floating-rate product is that it’s time yet again to dust off the responses to the many “what a rate cut means” inquiries related to our asset class.

Most are rooted in the age-old misperception that senior corporate loans are best positioned in portfolios only during “rising-rate periods”, and by extension that loans do not perform well at other times, least of all during periods of rate cuts.

Let’s turn to the facts. Consider the chart below, which summarizes performance during each of the three Fed rate-cut cycles experienced over the past two-plus decades. The analysis captures every rate-cut cycle since the inception of the loan market’s S&P/LSTA Leveraged Loan Index in 1997.

Specifically, the chart showcases the annualized forward returns of loans versus that of stocks and bonds, as measured from the time of the Fed’s initial rate cut. As asset class proxies, we use the S&P 500 Index for stocks and the Bloomberg Barclays U.S. Aggregate Bond Index for bonds.

Because the cycle of Fed cuts (and hikes, too) typically takes multiple years to play out, we assess the three-year forward period to both eliminate noise as well as capture a more complete picture of the relative investor experience across these asset classes.

Please click here for full article, which was provided by Eaton Vance.

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