Here is a quick recap of the 9/21/2022 Federal Open Market Committee provided by Caroline Groce, Southern California Regional Manager of Lord Abbott & Co., LLC. After reviewing them, feel free to comment on these questions to keep the discussion going:
Will the Fed continue to raise rates? Should they?
What is the long-term impact of returning rates to historical norms?
Can the economy recover from rates rising back to these historical norms?
September FOMC Meeting Highlights
- The US Federal Reserve (Fed) raised its target Federal Fund rate by 75 basis points (bps) for a third straight meeting, resulting in a target range of 3.00 – 3.25% yesterday afternoon.?While there had been a possibility of a 100-basis point move, the 75 bp move was largely expected coming into the meeting, based on Fed Fund Futures. With overnight borrowing costs now being raised by 300 basis points since March, this has been a very aggressive response by the Fed to recent higher than anticipated U.S. Consumer Price Index (CPI) data.?
- Based on the so-called “Dot Plot,” Fed officials expect their target to reach 4.25% - 4.50% by the end of the year, peaking at a range of 4.50% – 4.75% next year, up from the 3.75% level projected at the June meeting.
- While Chairman Powell unsurprisingly reiterated his focus on doing whatever is required to contain inflation, he did highlight the potentially positive trend that there are, at least, tentative signs that labor market pressure is easing, along with some other indicators of inflationary economic activity.?However, he also indicated that the path towards their inflation target may include both a weaker housing market and higher unemployment.
- However, overall economic activity has remained resilient, suggesting that large parts of the economy may not be particularly rate sensitive, creating a dilemma for the Fed as to how to soften price pressures in these areas. Importantly, Powell avoided being overly prescriptive with regard to future policy, highlighting that they remain highly data dependent and will adapt policy as they receive more information.
- Markets sold off in reaction, with S&P 500 Index declining by 1.7% on the day while the US dollar continued to strengthen.?Two-year US Treasury yields rose above 4.0%, while 10-year Treasury yields were mostly unchanged, leading to a further inversion of the yield curve.?It should be noted that initial reactions to recent Fed meetings have often reversed themselves in the days following as the market continues to digest new data.
- While aggressive Fed actions have resulted in sharply higher yields in the short end of the curve, market pricing suggests that inflation will moderate relatively soon, as illustrated in the accompanying chart of the 5-year / 5-year forward inflation swap. However, we believe there is a risk that inflation may persist and that investors are not being properly compensated for that risk in longer-dated US Treasury yields.?Given the shape of the yield curve and the uncertain outlook for inflation, we believe investors may want to reduce the duration of their high-quality bond allocations and take advantage of elevated yields on the short end.??
- For example, the recent yield of 4.83% on the ICE BofA 1 to 3-year Corporate Bond Index (as of 9/20/2022) is now 430 bps higher than its recent low. These higher yields offer an attractive entry point for investors and an opportunity for income with lower volatility and less rate sensitivity than intermediate core bonds.
Source: Bloomberg. 5Y5Y Forward Inflation Swap is a common measure used by central banks and dealers to gauge the market’s future inflation expectations. The historical data shown are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett.
Source: Bloomberg.?Past performance is not a reliable indicator or guarantee of future results.?For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.
