ACTV - The Fed Hikes But Eyes An Ending
Summary
- Market and policy trends continue to support fixed income assets.
- As widely expected, US Federal Reserve raised interest rates by 25 basis points at its latest meeting on Feb. 1.
- It appears that the Fed is not going to be so dogmatic as to force the economy into a major recession.
By Robert Dishner
Market and policy trends continue to support fixed income assets.
As widely expected, the U.S. Federal Reserve raised interest rates by 25 basis points at its latest meeting on Wednesday. Unexpectedly, however, Chairman Jerome Powell failed to push back against easing financial conditions as he had in the November press conference. This came at a time when the Chicago Fed's National Financial Conditions Index had reached its easiest level since last April when the fed funds rate was in the 25 to 50bps range. We see a number of implications for investors:
- Despite Powell's softer tone, we believe the Fed is likely to keep rates at higher levels for longer - and pausing isn't the same as cutting. The Fed is well aware of the impact that reducing rates too soon had in the 1970s and early 1980s, making the "Fed put" still out of the money. Rates will stay high until the central bank is more clearly on a path to its target. In the meantime, short-duration assets are likely to remain attractive for a while.
- It appears that the Fed is not going to be so dogmatic as to force the economy into a major recession. This should eliminate parts of the left tail of outcomes and has contributed to the recent risk rally. On the other hand, there is still potential downside for the economy, supporting continued dispersion in credit spreads.
- The current policy stance reinforces the case for lower but not low volatility in the markets. In our view, lower volatility would favor high-quality assets such as mortgages.
- On the other hand, it's possible that disinflation could slow or even reverse later in the year if financial conditions continue to ease.
That Chairman Powell was unwilling to push back forcefully against the market's pricing of rate cuts suggests that he believes that pricing could be correct. This tells us that the Fed is likely more data-dependent than it was last year. As a result, fixed income assets could continue to find support.
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The Fed Hikes, But Eyes An Ending