For Fed rate reduction

good morning. The US trade deficit fell 55% in April, according to the Commerce Department. There was a significant increase in exports, but the overall decline was primarily due to a decline in imports. Remember the argument that negative GDP reading from the last quarter will withdraw later this year as the tariff frontline is receding? It seems to be happening. Email: Unedged@ft.com.

Rate reduction

In December, the Federal Reserve revealed that its rate reduction cycle was pending until inflation and employment outlook become more clear. Six months after that declaration, there has been a strong case that the Fed should start cutting again. Not necessarily in June’s meeting, but soon. Today’s employment reports, which many speculate, are likely to be weaker, could bolster that case.

So far, the Fed has had every reason to leave it there. Inflation data tends to have a slower downward trend. The labor market worked, and sometimes I was surprised upside down. And despite the poor reading of sentiment, there is still little evidence of the impact of hard data inflation from Donald Trump’s tariffs.

But it may be just a matter of time. Soft data is less predictable than it used to be, but according to Guneet Dhingra, the main US rate strategist at BNP Paribas, soft data continues to fade. And that is the result of the central banks most feared: stags. Just this past week, ISM services have fallen into contraction, with new orders and prices rising, and built on months of rise. The ISM production photos were similar. New orders have fallen and prices continue to rise.

The same goes for the growing chorus says the Fed should look into the impact of Trump’s policy inflation. At this week’s meeting, Christopher Waller, a member of the federal government’s open market committee, filed his lawsuit over temporary tariff inflation.

Given my belief that tariff-induced inflation is not sustainable and that inflation expectations are fixed, I support examining the impact of tariffs on short-term inflation when setting policy rates.

Waller also emphasized that market expectations for inflation should be given more weight than survey data. The inflation swap market shows that inflation expectations are being cooled.

If there is no sustained inflation or unanchor’s expectations offshore, it can give the Fed more room to reduce the initial whims of trouble in the job market. That whim may come in today’s report. The ADP Employment Report earlier this week was cold: the private sector added only 37,000 jobs in May, well below expectations. It’s a temperament series, but there are signs of weakness elsewhere too. The rising number of people are not looking at it from unemployment, but rather from looking, not finding it, or not employed, to transitioning from unemployed. This was also a trend ahead of the previous slowdown. Chart from Troy Ludtka on SMBC Nikko Securities America:

If today’s work numbers come on the weak side and inflation continues to decline in the face of tariffs, the July cuts make sense.

(writer)

“alts”

Richard Ennis thinks alternative investments in your portfolio are a big mistake. And “You” not only covers individual investors, but also covers the usual goals of standard “allocation, index, rebalance, relaxation” advice. He believes even the most sophisticated pension and donation fund investors are seriously hurting their profits by owning hedge funds, private capital, real estate, venture capital and more.

Ennis, which includes establishing and selling his own institutional investment funds, and serving as editor of the Financial Analyst Journal, laid out his case in a new paper called “The End of Alternative Investment.” He argues that 35% of public pensions and 65% of donations are invested in alternatives (“Alt”), but this depends primarily on conflicts of interest and poor incentive structures between fund managers and consultants rather than risk-adjusted investment performance. Over the past 15 years or so, its performance has been awful for ALTs in all flavors.

His argument has two legs. Quantify the high costs of ALT, primarily by marshalling previously published studies. We then use new statistical analysis to show a strong correlation between higher exposure to ALT and lower investment performance.

For the cost of private assets, Ennis relies on a paper from Wayne Lim based on a large database of fee data from investment advisors that reveal the differences in total return and FEE net return ratios for various ALT strategies. This is Rim’s gruesome discovery table.

For hedge funds, the news is also bad. The academic studies cited by Ennis find on average the above average annual cost of assets.

The challenge comes with showing that returns from Alts justify or not justify the very high costs. “There is no reliable source of asset class-level return data for institutional investors,” Ennis said, as disclosures are sporadic and poor quality. Indexes aimed at tracking the outcomes of ALT investments are “hypothetical and ambiguous” non-investment. As an aside, I am amazed at the lack of industry standard reporting protocols for both funds and money managers. I asked Ennis why it wasn’t there. “This is a big problem,” he said. “No one has set standards. The CFA Institute was a major disappointment in this regard. There is no incentive to create the kind of resource you describe.”

However, what we have is a database that includes the overall performance of pensions and exposure to various categories of ALTS. Ennis performed regression using two large databases covering 2016-mid2024, two large databases, two large databases, and two large databases. We then compared the funds aggregation results in the database with a “market portfolio” of public indexes with the same equity and bond mix and the same volatility of returns as the funds. Pension funds have slowed the annual performance of around 1% in their market portfolio, with donations rising by more than 2%.

It appears that many or all of the reasons for poor performance are exposed to ALT. Performance and ALT exposure regression result in a statistically significant slope coefficient of -0.071. With each additional percentage of exposure to ALT, annual performance is just over 7 basis points. Ennis’ scatterplot represents each blue dot representing the pension fund and each green diamond, labeled 1-5, representing a cohort of upsized donations.

Ennis also beats performance by exposing him to different types of ALT. Real estate fares are particularly bad. He suggested to me that funds stick to it simply because “people are real estate investment suckers. Think Canary Wharf, Cadillac Fairview, etc. Real estate is concrete and can have incredible sexual attraction.”

Why are fund trustees and managers continuing to trust Alt managers with money given the miserable recent records? Chief investment officers and consultants can earn higher wages and appear smarter by supporting complex strategies. They also choose their own benchmarks and are drawn to bad benchmarks that appear to be acceptable for ALT’s performance degradation, Ennis argues.

I propose another explanation: the trustees and managers of that fund simply want a simple life. So, go with a money manager who can easily process billions of dollars checks, handle reporting and tax requirements smoothly, and have good reputations and high name recognition without ruining anything large. Therefore, a sophisticated back-office system and marketing practice puts the major managers in their obligations. And because the big managers are not stupid, they always push the finest products. The pension and donation industry (like most industries) is essentially lazy and inert. So, whatever a major asset manager wants to sell is default. But this is mainly just my speculation.

The strongest opposition I can think of to Ennis’ argument is that the last 15 years in the market have been extraordinary. Risk assets, particularly large US stocks, rose like crazy. In such an environment, the uncorrelated returns of hedging strategies and ALT are pure drugs of performance. Returning to a more relentless market environment, Alts proves its value once again.

I will never buy this entirely. If Ennis’ numbers are almost correct, the recent performance drug from ALT is so large that you’ll need surprisingly good results in the next market cycle. The burden of proof lies with the side of alternative investment managers and their fans in the world of pensions and donations.

(Armstrong)

One good read

boss.

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