Market Update

Market Update

December 13, 2023


The Fed Keeps Rates Steady


What’s important

  • The Federal Reserve (the Fed) today unanimously voted to maintain the current policy rate (basis points, or bps), leaving the Fed Funds Target Rate unchanged at 5.25% to 5.50%. This continues to represent the highest target range in over 22 years, though this pause also represents the third consecutive meeting in which the Fed has declined to adjust its policy rate. We believe that the theme of a Fed that’s laser focused on bringing inflation down to its 2% target remains intact as Chairman Jerome Powell reiterated that many times in his press conference.

  • The official statement changed verbiage around economic activity and inflation — noting that the former “has slowed” and the latter “has eased.”

  • The Summary of Economic Projections (SEP) showed a median year-end 2024 federal funds rate of 4.60%, which implies 75 bps of cuts throughout 2024. The unemployment median dot was unchanged at 4.10% for the end of 2024, while the core Personal Consumption Expenditure Index was revised slightly downward to 2.40%.


Fixed income

  • Rates markets rallied strongly for the duration of the Fed announcement as well as Powell’s press conference. The 10-year U.S. Treasury yield reached below 4.05% in a stunning move of nearly 100 bps since about two months ago. In terms of the daily move, the 10-year U.S. Treasury yield fell by roughly 15 bps from its opening around 4.20%, while the move in the two-year U.S. Treasury was even more drastic in yield terms — falling from 4.70% to 4.45%. Futures pricing swung strongly as well, with the implied probability of at least a 25-bp cut in March 2024 rising from 40% to 70% for an intraday move.

  • We remain defensive in our credit positioning but seek to increase investment–grade exposure tactically and selectively in corporate bonds, with the expectation that spreads should be resilient over the next six months. We continue to favor higher in credit quality (as we expect credit spreads to leak wider on the expected economic weakness). We advocate shifting from cash to the two&ndash to five–year area of the U.S. yield curve in order to take advantage of potential price appreciation as well as lock in an attractive carry yield in advance of broadly declining rates. Within tax-exempt markets, we believe that essential service municipals are better positioned for an economic downturn. We prefer active fixed income portfolio management, and fundamental credit selection will offer opportunities in these volatile times.

Equities

  • It’s looking more like this time was different for U.S. equities as they steam closer to all-time highs while participation in the “pivot party” broadens beyond mega–cap growth equities. Nearly 19 months to the day of the first rate hike in what would be the sharpest tightening cycle in U.S. monetary history, it appears that monetary policy has reached a peak, with evidence building that inflation is on a glidepath toward the Fed’s 2% target while the consumer remains more resilient than economic indicators suggested would be the case. In response to this afternoon”s SEP, which included a median forecast implying three rate cuts, stocks surged in the strongest rally on a day during which the Federal Open Market Committee held rates steady since at least 2010. More economically sensitive parts of the market, including Small Caps, outperformed.

  • To the extent that growth and inflation moderate to levels consistent with the Fed’s objectives, that may allow for financial conditions to loosen and help boost the outlook for equities. In our view, this provides strong kindling for more economically sensitive segments of the market, some of which had been pricing in more recessionary outcomes including Small Caps and Value. We also find reason for leadership to broaden beyond mega-cap tech leadership, which otherwise has served as a “hideout” for investors concerned with the economic outlook but reluctant to skimp on equities exposure.

Going forward

  • This meeting marked a significant shift in tone from the Fed. Coming into today’s conference, the Fed reinforced its “higher for longer” mantra; however, it pivoted slightly when discussing rate cuts and projecting it will do so in future meetings. After a rosy economic outlook shared at the last meeting, the Fed’s interpretation has shifted to slower growth in 2024.

  • We believe that the Fed now has rates at a level to fight inflation as policy rates are at a sufficiently restrictive level and the Fed has indicated that it will likely hold them there until inflation continues rapidly moving closer to the Fed’s 2% target.

  • As markets further struggle with a 5%+ terminal rate (the level at which the Fed is expected to stop raising interest rates), we expect pockets of volatility across equities and fixed income, especially as geopolitical risk remains elevated. We believe that the Fed will remain fully data dependent, and Powell reiterated that many times in his press conference. With November’s inflation data this week showing that it’s moving closer to the Fed’s 2% goal, it gives the Fed leeway to continue to pause further rate hikes and look at rate cuts as indicated in the SEP in 2024.
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