News & Insights

Perhaps the Fed Cut Too Much Too Soon

In September, the Federal Reserve slashed interest rates by an aggressive 50 basis points. The Fed also signaled continued rate cuts into 2025, seeming to claim victory over high inflation while shifting its focus to the employment side of its dual mandate. Unfortunately, their actions risk reigniting inflation.

The dovish positioning has spooked the bond market, with a runup in yields beginning the first day of the Fed meeting. Every Treasury from two to 30 years moved more than 50 basis points higher over the next month. Inflation swap and break-even rates also rose across the curve. Economic growth is running above potential GDP, putting upward pressure on inflation expectations, also reflected in rising bond yields. Throughout the runup in yields, the Bloomberg Economic Surprise Index surged, with much of the rise occurring coincidentally with stronger than expected economic data releases.

Uncertainty before the election regarding a potential Donald Trump win, along with the campaign’s announced tax and tariff policies, may have contributed to some of the rise, but it is unlikely to have been a substantial driver. Forecasting markets based on anticipated political outcomes is fraught with uncertainty, especially for the world’s deepest and most liquid financial market. An analysis from Benson Durham at Piper Sandler estimates that roughly five basis points of the pre-election rise can be attributed to increased expectations of a Trump win. With Benson’s precise forecast of an additional 15 basis point rise if he won, this is likely a credible attribution. This makes sense if you consider that the correlation between yields and Trump’s betting odds were very low. Another analysis from Neil Dutta of RenMac Research has a similar takeaway: About 80% of the move in bonds is attributable to changes in monetary policy expectations and strong economic data announcements.

The Fed may have shifted its focus away from inflation too soon, stoking expectations of more rate cuts in the future and risking embarrassment if they are forced into another reversal of policy. With gold, silver and Bitcoin rallying, the market seems to agree that the Fed’s current stance is too dovish.

1-Year Inflation Swap Rate

Source: Bloomberg

10-Year vs. 5-Year Breakeven Inflation Rate

Source: Bloomberg

Bloomberg Economic U.S. Surprise Index

Source: Bloomberg

France’s Struggles Cast Shadow Across EU Economy

Increasing economic instability in France is casting further doubt on the health and resiliency of the already weak Eurozone. For nearly two decades, France has run well above the EU’s debt ceiling of 3% of GDP ratio, with an explosion of government spending during the COVID-19 pandemic exacerbating the situation. This year’s deficit is expected to reach 6.1%, well above original projections, prompting a formal review by the EU. This has pushed the country to a public debt-to-GDP level of 112%, higher than Spain, a country shrouded in fears of a default a decade ago.

Economic growth remains stagnant, with tax revenues lower than expected despite one of the highest tax burdens in the developed world. France’s new government has proposed additional tax hikes and major spending cuts in hopes of stopping the bleeding, but a parliament lacking a majority coalition is unlikely to pass legislation anytime soon. As a result, Fitch lowered its outlook on France from stable to negative, citing the country’s inability to deliver sustainable budget discipline. The bond vigilantes are taking note, with France’s 10-year yield now trading above Spain’s for the first since 2008 when they decoupled during the Global Financial Crisis.

France’s precarious position is more the rule than the exception in the Eurozone today. France and Germany have long been considered the core of the region’s strength, making up nearly half of total GDP, propping up the rest of the zone during troubled times such as the European debt crisis of the early 2010s. Now, as both France and Germany are struggling, no other European country is large enough or healthy enough to return the favor (Greece, Italy, Spain and Portugal face problems of their own). With no savior in sight, the EU is more vulnerable to another debt crisis.

Euro Area is Not Just About Germany

Source: MRB

France vs Spain 10-year Bond Yield

Source: Bloomberg

Private Equity Markets Showing Signs of Life

Following a spending spree in 2021 and 2022, the private equity sector slowed, with below-normal deal activity for the past two years. Leveraged buyouts, especially, fell considerably as spiking interest rates made debt less attractive. The PE industry has been holding on to assets longer, unwilling to sell at depressed valuations. While PE investors accept lower liquidity for the promise of high returns, they are growing impatient as the slower pace of activity has delayed the typical cycle for return of their capital. As a result, PE fundraising has slowed, with investors less enamored with the longer lockups, and the frozen capital that is typically recycled into new vintages remains sidelined.

Exit activity is still weak, but deal volume has increased over the past two quarters, with new investments concentrated in growth-oriented acquisitions, as opposed to leveraged buyouts. In 2023, the number of growth equity deals surpassed LBO deals for the first time ever. Banks are slowly getting back into the LBO business as well, but the number of these deals are still down 33% compared to pre-COVID. Liquidity rebounded in the first half of 2024 with the recent increase in IPOs improving the pace of return of investor capital.

Private Equity Deal Activity by Quarter

Source: PitchBook

Private Equity Exit/Investment Ratio

Source: PitchBook

Private Equity Fundraising has Slowed

Source: Preqin

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Frost Investment Advisors, LLC, a wholly owned subsidiary of Frost Bank, one of the oldest and largest Texas-based banking organizations, offers a family of mutual funds to institutional and retail investors. The firm has offered institutional and retail shares since 2008.

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