Market Update

November 2, 2022

Fed Hikes Another 75 bps

What’s important

• The Federal Reserve (the Fed) today unanimously raised the Fed Funds Target Rate another 75 basis points (bps) to the 3.75%–4.00% range in a move that was well telegraphed by the Fed and anticipated by the markets. In short, with today’s additional hike, rates are now well into restrictive territory to help slow inflation.

• Language from the Federal Open Market Committee (FOMC) statement referenced “cumulative tightening” and “lagged impact” suggesting that this could be the last 75-bp hike, and the December rate hike will most likely be downshifted to 50 bps. Future rate increases will take into account the cumulative amount of tightening and the variable lags with which monetary policy affects economic activity and inflation.

• We still expect the terminal Federal Funds Rate to be 5%+ in early 2023 and that the Fed will stay at the terminal rate for some time, or perhaps even longer than in prior rate hiking cycles.

• Fixed income and equity markets were volatile throughout the press conference as the “higher for longer” theme was echoed.

Fixed income

• In Treasuries, there was a relatively modest reaction to the statement and press conference. Treasuries rallied meaningfully post-statement and then corrected during the press conference with yields slightly higher toward the end of the day. The overarching driver of the change in the direction of yields was during the press conference as the “higher for longer” theme was reiterated.


• We remain defensive in our credit positioning, with duration short to the benchmark and higher in credit quality (as we expect credit spreads to leak wider on the expected economic weakness). Within tax-exempt markets, we believe 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

• Equities initially reacted favorably to the reference of a lag in which policy affects economic activity and inflation, before turning negative as Fed Chairman Jerome Powell laid bare his commitment to raising rates higher and for longer. Equities experienced a drawdown of nearly 2% from when Chairman Powell began his press conference to its completion.


• We continue to remain defensive in our approach toward equity allocation and view the central tendency for equities to be biased lower. While the terminal level of tight monetary policy may be closer than expected, the eroding effects to the economy and corporate fundamentals is just beginning. As such we’d maintain a risk-off approach but would eye lower equity levels as potential opportunities to upgrade portfolio quality.


• We expect the bottoming process in risk assets to support more defensive segments that exhibit stable growth of sales and earnings. We expect sources of quality, low volatility and profitability to command a premium, whereas longer duration, high volatility and low visibility of earnings should compress.

Going forward

• With today’s 75-bp increase, the fourth consecutive hike of this size, the Fed reiterated it is “highly attentive to inflation risks.” While markets continue to worry that future Fed hikes will significantly hurt economic growth, the Fed continues to prioritize slowing inflation over economic growth, which will lead to longer-run economic sustainability.


• We expect the inflationary outlook to remain strong, pressuring policy rates to move higher and stay at those levels longer. Our view remains that while the pace of additional rate hikes is in flux, the terminal rate is expected to be 5%+ by the first half of 2023. We continue to expect future monetary policy action to be data dependent.


• We believe volatility (across both equity and bonds) will continue as there are lots of data releases between now and the December FOMC meeting (two additional inflation reports, employment and inflation sentiment reports), these releases will directly impact the Fed’s decision of the size of the rate hike in the December meeting. The final 2022 rate decision in December will give us additional insight into the Fed’s thinking as we will see the updated Summary of Economic Projections and a fresh look at the Fed’s estimate of terminal rate.