September 20, 2023
The Fed Keeps Rates Steady
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%. We believe that the theme of a still-hawkish 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 Fed’s Summary of Economic Projections (SEP) continued to show a year-end median Fed Funds Rate of 5.6%, unchanged from the last release of the SEP in June and implying one more 25-bp hike this year.
- The official statement only contained a few but notable changes. Job growth was characterized as “slowed,” while the previous statement labeled it as “robust.” The adjective to describe economic expansion was changed from “moderate” to “solid,” yet another level after the June statement characterized it as “modest.”
- Rates markets had a bit of a modest rally prior to the Fed meeting but gave some of it back on the long end and all of it back on the short end. Of course, the more policy-sensitive shorter end of the curve likely sold off given the implied pushing back of cuts in 2024 showed by the dot plot. Overall, the move was fairly benign, and it appears the market easily digested Powell’s remarks as not changing much.
- We remain defensive in our credit positioning and are moving to a very modest duration extension relative to the benchmark. We 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 gyrated on today’s comments from the Fed, with the S&P 500 momentarily moving higher after digesting the SEP, before settling nearly 1% lower on the day. The trajectory of yields appeared to have the largest impact on stocks with faster growth, higher duration and faltering speculative segments, while Value, Quality and more defensive sectors were more resilient.
- Going forward, we flag the risk that Fed policy will remain higher for longer as stress in the banking system looms while a restrictive monetary stance continues to weigh on economic growth. In our view, this would support a focus on defensive growth, quality and profitability outside of mega-cap leadership.
- The biggest takeaway is probably that the Fed wants to see further sustained declines in inflation. If Powell’s goal was to not spook markets and to maintain the Fed’s data dependency, his press conference accomplished that in our view. We felt he did a good job of continuing to maintain a hawkish posture despite inflationary data that’s moving closer to the Fed’s 2% target. The October/November meeting should be a critical one, not so much in terms of whether or not to raise rates but to clue us in to how the Federal Open Market Committee interprets the inflation and labor data.
- We believe that the Fed now has rates high enough to fight inflation as policy rates are at a sufficiently restrictive level, and the Fed has indicated that it’s likely to hold them there until inflation starts rapidly moving closer to the its 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. We believe that the Fed will remain fully data dependent, and Powell reiterated that many times in his press conference. Between now and the October/November meeting, the Fed will have additional economic data to help it make a 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 pause rate hikes.
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