With a few days to digest the rate cut, it’s now time to think about what happens now that interest rates are going down: (1) All the money in short term bills may have to be deployed in other asset classes as their attractiveness will inevitably decrease. (2) Will the money go to long duration bonds? If we don’t have a recession and there is economic growth, the yield curve slope will likely steepen. Perhaps the long duration trade makes more sense if we’re in a recessionary environment. (3) Equities are a long duration asset, but as long as earnings continue to grow to justify their valuation, they may attract some of those flows. (4) In terms of credit, it’s difficult to see tighter spreads, but they can stay ranged bound close to current levels for some time until there’s more clarity on how the economy is going to adjust. The key to the new regime is probably going to be unemployment, in the absence of inflation surprises.
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