Fed Surprises & Inflation Shocks: What You Need To Know for 2025’s Fixed Income Market With Kevin Flanagan

Julia Smollen: So to start off our questions, what are the key takeaways from the December Federal Open Market Committee meeting and how might they affect the monetary policy moving forward?

Kevin Flanagan: Yeah, it's interesting that the results themselves weren't a surprise.

In other words, we got another rate cut from the Fed. So that makes 100 basis points worth since September. 3rd in a row. But I think where the surprise came in were, expectations for next year where the fed dialed back their own forecasts using the dot plot, from four rate cuts to two. And I think that caught some of the markets by surprise, [00:01:00] not necessarily us per se.

We did think the fed was going to pull back on their rate cut expectations and how it shapes monetary policy going forward is I think the fed is going to be more cautious. I think the incoming economic numbers have been a lot different. In other words, not as supportive for rate cuts as when the Fed started the process back in September.

So I wouldn't be surprised if the Fed took a pause to begin 2025.

Julia Smollen: And talking on inflation, how do you see inflation evolving into 2025? And what implications does this have for interest rates in the fixed income landscape?

Kevin Flanagan: Well, inflation, based upon the official numbers seems to have hit a little bit of a roadblock, of late. Especially when you're looking at core numbers year over year, they've been kind of stuck right about at the same levels they were three, four, five months ago. And I think the Fed is seeing that and has been disappointed as [00:02:00] well. Hence to your prior question, why some of the change I think in the monetary policy outlook. And that's why I think you will see a continued bumpy path for inflation.

Reaching the feds 2 percent goal, I think is going to prove to be elusive. Don't necessarily see a reignition of price pressures, at least in the first half of the year. So I think that's going to keep interest rates elevated, say for treasuries per se, and it's going to keep the Fed on their toes and perhaps on the sidelines and not be in any hurry to cut rates. And that will obviously impact fixed income and how you should position your portfolios because now rates look like they're going to be higher for longer.

Julia Smollen: And the yield curve has been closely watched this year. Do you expect any changes in 2025 and what should investors be considering when positioning portfolios?

Kevin Flanagan: the yield curve is uninverted. Uh, if that's a term, I don't know if that's in the Merriam Webster dictionary or not. [00:03:00] But essentially what that means is there's no more negative spread relationship between shorter dated maturities and longer dated maturities. Specifically in the treasury market. And that's a good thing. You want the yield curve to normalize I think over time. We're not there yet.

The curve overall from a historical perspective is still flat. But I think as we move further into 2025 that you will more than likely see the yield curve continue to steepen. So to move further away from flat or negative and become more entrenched into positive territory. And investors when looking at that kind of positioning should be focusing on something like a barbell approach, where you're not really putting your chip on the table, making a specific rate call. You're kind of anchoring in what you're focusing on in terms of shorter duration, being less [00:04:00] susceptible to potentially higher rates and then it's a intermediate or core duration.

If you wanted to try to lock in some of the yields that are available. So it's a time tested strategy. And I think in a yield curve steepening and environment. Something for investors to consider.

Julia Smollen: Given current conditions. Where do you see the most attractive opportunities within fixed income sectors in the coming year?

Kevin Flanagan: Well, you know, great question. Going back to the barbell that we were just talking about, I think the cornerstone for that are treasury floating rate notes. And oftentimes people look at those instruments as just being rate hedges, but they're more than that. I think they can have a more strategic kind of outlook to them.

And once again, you're seeing yield levels not too far removed from, say, being further out on the yield curve, but not with the same kind of volatility that we've been witnessing in the bond market of late. I think another area to be looking at would [00:05:00] probably be focusing on, perhaps, mortgage backed securities, where, unlike U. S. credit, investment grade and high yield, which seems expensive, I think you could make a case there's relative value. In the mortgage backed space.

Julia Smollen: What potential risks could disrupt the fixed income markets in 2025 and how should investors be preparing for these scenarios?

Kevin Flanagan: You know, it's always the question right? People ask you what keeps you up at night. For me, we are getting a new fiscal policy backdrop in 2025. You have a new president, you have a new congress. So we kind of have to wait and see what will the tariff plan actually look like or get implemented. What kind of potential legislation could come down the pike? That's not something I think you can really necessarily prepare for ahead of time It may be a little bit more reactionary rather than being on that front. And I would think if there was one risk, now, I'm not saying I think it's going to happen, [00:06:00] but, what if you do get inflation reigniting? Could the fed actually consider raising rates a year from now?

Julia Smollen: And finally, to wrap up, do you have any advice for financial advisors looking to allocate to fixed income in 2025, given the environment and market uncertainties?

Kevin Flanagan: I think, you know, going back to the barbell strategy we were talking about, oftentimes investors look at barbells as being a way to manage duration, but it's more than that.

You can manage your interest or credit sensitive allocations to fixed income, as well as an active or passive approach to fixed income. Now, what we've been talking about is a more normal rate setting here going into 2025. And I think investors would be, I think, should be recommending, or we're recommending, should be looking at an active passive approach.

Julia Smollen: Thank you so much for joining us again, Kevin. We always appreciate your time.

Kevin Flanagan: Thank you very much.

Julia Smollen: To learn more about WisdomTree, please visit WisdomTree.com. Please follow us for timely updates on X, [00:07:00] LinkedIn, and Facebook, all @Advisorpedia. For everyone at Advisorpedia and the Power Your Advice podcast team, this is Julia Smollen.