Market Update

September 21, 2022

Fed’s Fall Rate Hike

What’s important

• In a unanimous decision, the Federal Open Market Committee (FOMC) decided to increase the Fed Funds rate by 75 basis points (bps) for a third consecutive meeting, which brings the Fed Funds rate to 3.00%–3.25%. With inflation significantly above the threshold of the Federal Reserve (the Fed) and stickier than anticipated, the policy statement maintained a hawkish tone — meaning the Fed has more work to do.

• The FOMC’s assessment of current macroeconomic conditions acknowledged the economy has weakened since July; however, the strong labor market keeps inflation pressures high. The FOMC’s view on inflation was unchanged: Inflation remains elevated due to supply and demand imbalances related to the pandemic, higher food and energy prices, and broadening price pressures.

• The accompanying Summary of Economic Projections confirms the likelihood that the Fed acts aggressively in its mission to return inflation back to its 2% objective, pushing the policy rate higher than previously expected and keeping it higher for longer. The FOMC’s revised economic projections also acknowledge the toll that higher rates will take on the economy.

Fixed income

• In response to the hawkish reaction of the Fed, U.S. Treasury yields moved higher, and the U.S. dollar strengthened. Yields across the U.S. Treasury curve moved higher led by the 2-year, as is typical given the Fed’s hawkish posture. Since the initial market reaction to the Fed’s decision, yields have retreated and are settling in as the market was able to digest the decision. We continue to expect interest rates across the yield curve to rise, with the yield curve remaining flat and inverted at certain points.


• 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 actually moved higher during Fed Chairman Jerome Powell’s early remarks before settling down and moving sharply lower for the session, with a peak-to-trough decline of 2.8% for the S&P 500. Coming into this meeting, most of the heavy lifting in resetting expectations had been done by Chairman Powell at the Jackson Hole Symposium, and equities had reacted with large caps having declined nearly 8% since.


• In our view, downward pressure on equities will persist through year-end as earnings estimates reset lower and relative valuations offer little reprieve. Corporate earnings will likely come under duress as a tighter monetary backdrop weighs on revenues while margins compress under the weight of higher input costs.


• We expect the bottoming process in risk assets to support more defensive segments that exhibit stable growth of sales and earnings. We also 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 third consecutive hike of this size, the Fed reiterated its commitment to fight inflation. While markets continue to worry that future Fed hikes will significantly hurt economic growth, the Fed continues to prioritize slowing inflation over economic growth, and that 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. However, the magnitude of future monetary policy actions will be data dependent, causing rate volatility to remain elevated for the foreseeable future.


• Volatility will persist across stock and bond markets until there’s greater clarity on the path of inflation moving toward the Fed’s 2% target and whether there are future escalations in the invasion of Ukraine and any changes to China’s stop-start COVID policies, which are stressing global supply chains.