The Fed Hits Pause…For Now.
By Matt Tourville
Three months ago, this market commentary observed that predictions for future Fed tightening had greatly diminished in the wake of the collapse of Silicon Valley Bank. That commentary went to print while the SVB news was still fresh, and potential contagion across the banking system was the topic of the day. Three months later and that seems almost like ancient history. Not only has the market moved on from fears of a systemic banking meltdown, but we have survived the rise and fall of another “crisis” entirely in the form of the debt ceiling impasse in Washington.
With two near-catastrophes averted over the past few months, it is perhaps refreshing that the most recent “news” for the markets was considered a well-telegraphed non-event. After increasing the target range for the federal funds rate at the previous 10 consecutive meetings since March 2022, the Federal Open Market Committee (FOMC) chose to keep rates the same during last week’s policy meeting Following the announcement, Federal Reserve Board Chair Jerome Powell emphasized the Committee’s pause on changes to the fed funds rate at the June meeting was not a full stop or an indication that further rate increases were off the table for future meetings.
Members of the FOMC intend to remain diligent with regard to cooling, but still historically high inflation. This is most evident by reviewing the June release of the “dot plot”, so named because it’s a chart that represents the view of each respective FOMC member as expressed by a dot on a graph with the axes being the fed funds rate and time as measured by future months with policy meetings. The message from the June dot plot reveals that there is still a bias by members towards further rate hikes, with the median among the respective predictions forecasting the Fed Funds rate of 2.6% by year-end 2023. This implies the FOMC will increase rates another roughly half percent in the months ahead, which could be accomplished through a single half-point move or a pair of quarter-point increases.
Policy makers at the Fed continue to convey a message of “higher for longer” in demonstrating their collective resolve to combat inflation. This means that while the June “pause” and what likely limited future increases may signal an end to an aggressive tightening cycle, the fed funds rate may remain elevated for a longer period than seen in previous cycles. Although, the Fed and the markets did receive some welcome news just prior to last week’s FOMC announcement. The U.S. Bureau of Labor Statistics released the May Consumer Price Index (CPI) on June 13th, and the CPI was the lowest reported in more than two years at 4.0%, down from 4.9% in April. It seems the Fed’s inflation-fighting campaign is creating the desired effect, but again, future actions relative to the target range for the fed funds rate will depend on new data.
At times like this, it’s important to weigh what we perceive to be the Fed’s view against that of the “market.” Based on data from last week, there’s not presently a tremendous amount of misalignment. This is a change from recent months when the gap between investors and the Fed was much wider, as the market was pricing cuts to the fed funds rate by at least the conclusion of the September meeting. The current view of market participants based on fed funds futures pricing is that the “terminal” or peak rate for fed funds is about a quarter-point less than the 5.6% that’s set out in the most recent dot plot. There’s also some inconsistency in thoughts around how quickly the Fed gets there, but the magnitude of these disparities is far less than just a few months ago.
There is always a watchful eye on the Fed and its policy actions. However, the gaze tends to come into sharper focus when we are at inflection points. Short-term rates are the highest in roughly 15 years, and municipal investors welcome a meaningful return on their cash. Further, there is a healthy gap between short- and intermediate-term rates – as much as almost 1.50% between 6-month and 5-year Treasuries. However, the market will turn, and the current inversion will likely diminish at a brisk pace. Investors need to balance their desire for those juicy yields on the front-end with a durable portfolio that provides predictable income for years to come. At Ehlers, we seek to assist our clients in crafting portfolios that are resilient in the face of market dynamics, such as those in front of us today. It’s foolish to think that we’ll spot that specific moment in time with precision, so it’s important to stay humble in our ability to prognosticate and stick to the time-tested measures of policy and rigor.
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