By Jeffrey Hibbeler, Director of Portfolio Management & Senior Portfolio Manager
The Federal Reserve (Fed)'s current monetary policy, including the anticipation of a rate cut at next week’s Federal Open Market Committee (FOMC) meeting, is a pivotal topic for investors right now. Here's a breakdown of the situation and what it might mean for markets and our strategy moving forward.
The Fed initiated an aggressive rate-hiking cycle in March 2022 as inflation rates soared beyond its targets.1 Initially, there was skepticism from market participants about the effectiveness of these policies and the Fed’s ability to tame high inflation. Over time, it's become evident that these measures have curbed inflation growth, which has come down from its 2022 highs but still hovers above the desired levels.2 We’ve seen job growth continue, but at a slower pace while the unemployment rate has ticked up, often a signal of an impending recession.3 Given the Fed’s progress toward its inflation targets and the need to keep the labor market stable, the central bank is now at a point where rate cut conversations are realistic.
The general consensus is leaning toward a rate cut at next week’s meeting, likely by 25 basis points. At the start of this year, the market was aggressively pricing in six or seven rate cuts,4 which our team saw as overly optimistic. Now, the Fed’s assessment of recent economic data is pointing in the direction of a rate cut. Some uncertainties remain, however. Namely, estimates for the Fed's neutral funds rate, once projected as low as 2.5%, have recently edged up to 2.8% and will affect the potential scale of the Fed’s rate cutting cycle.5
August’s employment report was anticipated to cast the final “vote” in determining whether the Fed may need to be more aggressive and cut by 50 basis points in September. However, there were arguments supporting both camps in last Friday’s report, which showed continued expansion in the labor market, although at a pace that is incrementally slowing.6 Also guiding their decision, Fed officials have noted they remain focused on broader economic trends and overall financial conditions, which remain relatively stable.
Looking forward, investors will be focused on the Fed's expectations for subsequent rate cuts and how the markets will adjust their pricing for future rates. Clearly, more information is needed, and two key inputs at the upcoming FOMC meeting will be critical: the press release detailing the new set of economic projections and the funds rate “dot plot” forecast, as well as Chairman Jerome Powell’s press conference where he will elaborate on the committee’s perspective of monetary policy.
For fixed income investors, the current climate presents both challenges and opportunities. Although some rate cuts are already priced in, our view is that yields are more likely to fall, rather than rise over the medium term. And, as the Fed starts normalizing rates, we expect the yield curve to continue on its steepening path.
As we know, markets are reactive, often swinging more dramatically than the underlying facts might suggest. While the Fed aims for a soft landing, we anticipate it adjusting rates deliberately to avoid a bounce back in inflation, but expect a degree of volatility. Maintaining balanced exposure to short and longer-term investments to manage risk and provide stability remains key.
If you have any questions or need further clarification on how these developments might impact your portfolio, please don't hesitate to reach out to your Exencial advisor.
Sources
- Federal Reserve Bank of St. Louis (data as of 8/29/24) – Federal Funds Effective Rate
- US Bureau of Labor and Statistics (8/14/24) – Consumer Price Index Summary
- Reuters (7/5/24) – June US job growth moderates, unemployment rate ticks up
- CNBC.com (1/30/24) – The Fed will cut rates fewer times and start them later than market hopes, according to CNBC Fed Survey
- Reuters (6/14/24) – NY Fed data shows neutral rate holding steady at low level
- US Bureau of Labor and Statistics (9/6/24) – The Employment Situation – August 2024
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