The Fed Holds Rates Steady
The Federal Reserve voted unanimously on Wednesday to maintain the current policy rate, leaving the Fed Funds Target Rate unchanged at 5.25% to 5.50%. The Fed’s intention to bring inflation down to its 2% target seems intact. The most important notable change in the Fed’s rhetoric was the acknowledgment that tighter financial conditions are weighing on markets, a nod to the increase in U.S. Treasury rates since the last Fed meeting.
We believe the Fed will hold rates ‘steady for longer’ as it continues to closely monitor economic data, particularly labor and inflation. Some indicators point to potential rate cuts beginning as early as June 2024.
Fixed Income
The Fed has raised rates 11 consecutive times, 4 of these hikes taking place in 2023. This rise in rates has put a strain on bond prices and we agree with the consensus that bonds are now greatly oversold. We continue to favor bonds of higher credit quality and are maintaining positions in active fixed income bond portfolios in anticipation of potential price appreciation when broader rates begin to decline.
Equities
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. We believe this process would support a focus on large-cap US equities including sources of quality, profitability and stability.
Going Forward
We 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 risks have escalated. This expectation reinforces the recommendation of maintaining a balanced and diversified portfolio.
Powell reiterated many times in his press conference that they will keep a sharp focus on data. 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.