The Federal Reserve will start to ease its monetary policy this year and should even implement a couple of rate cuts to prevent a potential recession, according to a quarterly update issued by Vanguard’s fixed-income group.

Dan Shaykevich, senior portfolio manager at Vanguard, told Financial Advisor in an interview that he does not expect a full recession, though he did clarify that should the monetary policy remain as restrictive as it has been, a recession is possible.

“At some point, if rates are indeed restrictive, you are going to see a slowdown in consumer spending, and eventually it is going to affect the markets,” he said.

While there is not a lot of evidence of an imminent collapse in consumer demand, the firm is always looking for any early signs of it, he added. 

"The Fed is taking a lot of comfort in the strength of the labor markets and the strength of the overall economy,” he said. “That gives them a lot more leeway in terms of timing where they’re not as worried about an imminent recession, therefore they’re willing to be a little more patient.”

However, should something dramatic occur over the next several months, it could change the Fed’s plans, he said. As of now, Vanguard does not anticipate a rate increase, and it’s optimistic about at least one possible rate cut.

“Outside of a financial volatility accident ... we think it’s quite likely that the Fed is going to limit itself to one cut this year or maybe two,” he said.

Inflation has been a stubborn problem. It reached over 9% two years ago. While it has been down in recent months, it has not matched the levels it was at more than four years ago when it was between 1% and 2%.

While there is always a risk that it could reaccelerate, that’s a minor concern, according to the report. Shaykevich does not believe that the industry will see it decrease anytime soon given the historic levels it has already reached.

“The fact that inflation has been higher for as long as it has been higher makes it more difficult to get it back down to the original levels,” he said. “I do expect that it will take a little while before we see substantially different levels of year-to-year inflation that we are seeing today.”

As far as opportunities for investors, there is still a lot of uncertainty in the financial markets, so advisors should focus on products that can evolve quickly, Shaykevich pointed out.

“The world can change relatively quickly,” he said. “A world where there’s not a lot of opportunities today can change into a world where there are a lot of opportunities ... and that’s where flexible products come in.”

While Vanguard is traditionally thought of for its expertise in indexing, the Malvern, Pa.-based firm is one of the largest active fund providers, with $1.7 trillion in actively managed stock, bond and balanced funds, according to a fund spokesperson. 

Shaykevich thinks active managers can benefit in this environment because they can identify those segments that may not be performing well and swap out one investment for one doing better.

“Prolonged periods of high interest rates are going to cause stress among segments and for us as an active manager, it’s very important to identify those segments and try to reduce exposure to them,” he said. “Active managers can really identify assets that are mispriced and make sure the clients have them in the portfolios.” 

There are areas that advisors should be wary of as well. One of those is U.S. high-yield investments, Shaykevich explained. They include smaller companies that do not necessarily have long-term financing at fixed rates. They also tend to feel the pain sooner than larger companies.

While Vanguard still invests in the segment, Shaykevich said the firm is defensively positioned within it. 

Another investment type to be wary of are those that do not allow an investor to get out on demand. Given the fluctuations in the market, advisors will need to get clients out of certain funds quickly, Shaykevich said.