November 1, 2023
The Fed Keeps Rates Steady
Today, the Federal Reserve (the Fed) voted unanimously to maintain the current policy rate (basis points, or bps), leaving the Fed Funds Target Rate unchanged at 5.25% to 5.50%. 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 at his press conference.
The official statement contained a few but notable changes. Most important was the acknowledgment that tighter financial conditions are weighing on markets, a clear nod to the increase in U.S. Treasury rates since the last Fed meeting.
On balance, we think that the meeting tilted slightly hawkish, particularly the statement from Powell that the Federal Open Market Committee (FOMC) “is not yet convinced” that rates are at a sufficiently restrictive level to get inflation down to its target.
- Rates markets were unchanged after the announcement, maybe a hair higher in certain maturities, for the duration of Powell’s press conference. That’s to be expected, as this meeting didn’t include a policy action or Summary of Economic Projections. Of course, rates do have a large intraday rally stemming from the U.S. Treasury’s announcement this morning that borrowing in the fourth quarter would be less than anticipated.
- We remain defensive in our credit positioning but do 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- to five-year area of the U.S. yield curve in order to take advantage of potential price appreciation as well as locking 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.
- U.S. equities responded with aplomb to today’s FOMC developments. After shrugging off the FOMC’s decision to hold policy rates level, most of the market reaction was confined to Powell’s press conference. Equities initially began to retreat during the question-answering session as Powell indicated that financial conditions, including equity valuations and bond yields, likely need to remain at a restrictive level to dampen economic growth to a degree more consistent with the Fed’s inflation objectives. However, the tide began to turn when Powell suggested that the potential outlook for balanced growth may be higher than previously thought given the expansion of the labor force. This would appear to indicate that a period of softness in the economy, which the Fed suggests is necessary to bring inflation down to its 2% target, may not be severe.
- We anticipate that tighter policy and higher interest rates will continue to weigh on economic growth while geopolitical risks mount. 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 process would support a focus on defensive growth including sources of quality, profitability and stability, which may include mega-cap leadership.
- Overall, this meeting didn’t include any major changes to the Fed’s messaging; the comments reinforced its goal of a 2% inflation target and that it will remain data dependent. If anything, this meeting may have nudged the “higher rates for longer” mantra into “even higher rates for even longer” territory, and we do think that another 25-bp move higher is squarely on the table. Labor and inflation data for October and November are, of course, important for the Fed’s next December meeting, but proceeding carefully continues to be the Fed’s general consensus at this point in time.
- We do believe that the Fed now has rates close enough to 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 starts 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 have escalated. We believe that the Fed will remain fully data dependent, and Powell reiterated that many times in his press conference. Between now and the December meeting, the Fed will have additional economic data to help make its next decision on whether to continue hiking rates or pause. If the data consistently continues to move closer to the Fed’s 2% inflation target, that will give the Fed leeway to potentially continue to pause further rate hikes.
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