Podcast: Fed to Shrink Balance Sheet at Slower Pace - May 1, 2024

The U.S. Federal Reserve made a big announcement — and it’s not about interest rates. In today’s episode, Portfolio Managers Matt Montemurro, Chris McHaney, and your host, Erika Toth, explore changes to the Fed’s quantitative tightening, or QT, program. They also discuss results from the earnings season so far, Canadian GDP numbers, and Japan.

Erika Toth is a Director of Institutional and Advisory for Eastern Canada at BMO Global Asset Management. She is joined on the podcast by Matt Montemurro and Chris McHaney, Portfolio Managers and ETF Specialists at BMO Global Asset Management. The episode was recorded live on Wednesday, May 1, 2024.

Episode Summary

U.S. Monetary Policy

The U.S. Federal Reserve’s (Fed) message with their policy decision was that they are not happy with recent inflation progress. The economy still looks strong, unemployment numbers are still good, which isn’t the worst-case scenario. They were not as hawkish as some pundits may have feared. In addition to holding rates steady, as expected, the committee decided to taper their Quantitative Tightening (QT)¹ program. The move will slow the rate at which the Fed’s balance sheet shrinks, thereby diminishing all the additional monetary tightening that was in the system. They are trying to avoid what happened 2019, but still reduce that balance sheet size over time. Market participants were wondering whether they revise that target upwards, but the message was clear that they are firm with the 2% inflation target.

Earnings Season

It has been a mixed bag so far. You can’t say it’s been too negative or positive. Even within sectors, we are seeing some divergence. For example, within the tech sector, Amazon generally reporting positive earnings, but Microsoft was more of a negative earnings result. We also have seen some weakness within the retail sector. So the message is to stay diversified. We’ve noticed from the options market that volatility around earnings has picked up. So, for option sellers, strategies that have an embedded call writing or premium cash flow generation tends to benefit from that. For investors that have S&P 500 exposure or similar, and want to dampen the level of volatility around these earnings cycles, you can look to blend in a little bit of factor exposure such as low volatility and quality. Generally, when one factor zigs, the others zags. So, if you blend these types of strategies together, you get a dampening of that volatility without giving up too much growth.

• BMO Low Volatility US Equity ETF (Ticker: ZLU)
• BMO MSCI USA High Quality Index ETF (Ticker: ZUQ)

Canadian Economy

Higher rates are starting to hit home in Canada and the data continues to show that we’re seeing meaningful slowing of the economy. Persistent higher rates are making their way through the economy faster than we’re seeing south of the border. The slowing economy gives more fuel to the fire for rate cuts to potentially come soon. The market is pricing in about a 56% chance of a June cut. The next CPI print come out in a few weeks and that might be the final nail in the coffin for whether a rate cut will happen in June. Just two cuts are priced in now for 2024, which is well below the initial estimates and expectations. It does seem like both the Bank of Canada and the Fed are willing to diverge.

International Markets

The Japanese yen over the past few weeks continued to weaken, in particular against the U.S. dollar. A continuation of a trend that that started a couple of years ago. There were indications that perhaps the Central Bank of Japan will step in to perhaps support the currency. , equities have done very well in Japan over the last year or two. a lot of that is because they are an export-oriented economy. And so a weaker yen actually helps the companies in Japan. For exposure to Japanese equities, currency is an important consideration. And certainly there are BMO ETF hedged and unhedged options for investors. I would suggest maintaining the majority of your exposure hedged to the Canadian dollar if you are invested in Japanese markets, to just remove the currency noise. It is hard to predict, with central bank intervention, which way things will go from an investment perspective. Investors should seek professional advice with respect to any circumstance.

• BMO Japan Index ETF (Ticker: ZJPN)
• BMO Japan Index ETF (Hedged Units) – (Ticker: ZJPN.F)

¹Quantitative Tightening: Monetary policies that reduce the debt load on the U.S. Federal Reserves’ balance sheet, further reducing liquidity in the markets and raising rates.