TLT - September Fed Meeting: Key Takeaways After The Rate Pause

2023-09-20 16:43:13 ET

Summary

• On Wednesday, the Federal Reserve kept its benchmark borrowing rate unchanged at its current range of between 5.25% and 5.50%.
• Though the decision was widely expected, equity markets shed their earlier gains immediately following the release.
• Of greater importance was the dot plot, which indicated rates are likely to stay higher for longer.
• While inflation is expected to be lower in the months ahead, elevated gasoline prices and the effects of recent labor movements can create further upward pressure on prices.

The Federal Open Market Committee (“FOMC”) met rate expectations at its sixth policy meeting of the year by holding steady. While this decision was widely anticipated , observers were likely looking for more hopeful signs of conclusion in the rate campaign. And on this, the Committee may have disappointed the wishful. I, however, view it as the right call, especially when considering factors such as rising gas prices and positive momentum in various labor movements and its potential impact on prices in the coming months.

What Was The Fed’s Policy Announcement?

Following an increase to a 22-year high in their July meeting, the FOMC kept its benchmark federal funds rate at its current range of between 5.25% and 5.50%. This represents the second time in six policy meetings that the Fed has paused on raising rates.

In their release, the FOMC stated that “ it will continue to assess additional information and its implications for monetary policy. ” This is the same line the Committee used in their last release, and it is indicative of the notion that the job is not yet done.

Why Did The Fed Keep The Benchmark Rate Unchanged?

In holding steady, the FOMC noted that economic activity has been expanding at a “solid” pace. This contrasts with prior language from July, where they stated it’s been expanding moderately.

Less subtly, the FOMC acknowledged that job gains have slowed in recent months. This follows data from the last jobs report, which showed employers added an average of 150K jobs over the last three months, down from the 238K average added from March through May.

Despite the slowdown in job additions, the FOMC recognized the underlying strength in the labor market, citing the still-low unemployment rate, as well as the elevated inflation rate. This is likely why the Committee left the door open to at least one more hike in either their November or December session.

Market Reaction To Fed Rate Decision

The openness to at least one more rate increase dampened markets to some extent immediately following the release. In equities, the Dow ( DJIA ) gave up most of its 200+ point edge held earlier in the day, while both the S&P (SP500) and Nasdaq ( NDX ) traded further in the red, but more so in the tech-heavy Nasdaq.

In bond markets, the 10-year Treasury ( TLT ) yield tracked lower to 4.3%, down slightly from yesterday’s close , which marked the highest level since 2007, while the 2-year yield continued its ascent from its highest level since 2006.

What To Expect Moving Forward

The median projection in the Fed’s dot plot showed officials expect at least one more rate hike this year, matching projections from June. Additionally, the majority stood at 12 policymakers, equivalent to the count in June.

But more importantly, the median projection for next year’s rates increased to 5.1%. This would be up from 4.6% seen in the last meeting. Driving this was two fewer expected cuts next year. This provides evidence that officials believe inflation will remain stickier than initially anticipated.

This could be due in part to their sharp revision in their economic forecasts. GDP is now expected to increase by 2.1% this year, up from their prior estimate of just 1%. Officials also expect a smaller rise in the unemployment rate compared to what they had estimated previously.

Though policymakers expect inflation to be stickier, they aren’t necessarily expecting it to be higher. Expectations for annual core inflation ticked lower to 3.7% in the fourth quarter, down from the previous estimate in June of 3.9%. Even more distinct is the view for the 12-month core rate, which is seen at 3.8%, down 70 basis points from their last projection.

Even at those levels, inflation would still be well above their 2% target. Taken together, the Fed is seeing demand for labor moderate and is seeing evidence of declining inflation. They likely are attributing some of this to their cumulative efforts thus far. But they aren’t getting comfortable enough to call it “job complete;” hence the pause.

My Prediction

Elevated prices at the pump and the momentum in various labor movements are likely to put upward pressure on prices in the next three to six months. These advances are unlikely to be quelled by Fed policy due to the unique circumstances surrounding each.

The recent spike in gasoline prices, for example, is attributable to Saudi Arabia’s decision to extend output cuts through the remainder of the year. Organized labor, likewise, takes little que from the state of interest rates. These factors are likely best addressed through means outside of monetary policy.

I expect the recent UAW strike to lead to an uptick in the vehicle component in the near-term CPI readings. I also expect the effects of elevated fuel costs to feed into other ancillary components, such as airfare. An expected decline in the shelter component may provide an adequate buffer against these increases.

I, nevertheless, believe core inflation will end the year higher than expected. In my view, this makes the prospects of any rate cut next year, contemplated by some, unlikely. With higher rates probable for longer, I see value in maintaining an elevated buffer of cash and equivalents.

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