Decisions will continue to be made on a meeting-by-meeting basis, and while there has been meaningful progress in bringing inflation closer to target, progress will be “lumpy,” and the Fed is not yet ready to declare the fight finished.
On Wednesday, the Federal Reserve (Fed) announced that the target range of the federal funds rate of 5.25%-5.50% will remain unchanged. The decision was unanimous, expected, and consistent with September’s meeting. Modest changes within the statement included an acknowledgment of the strong third quarter GDP growth experienced in the U.S., as well as moderated job gains when compared with earlier in the year. A more notable change was the addition of the term “financial” to “credit” when describing conditions for consumers and businesses, which we believe indicates that the Fed believes that these tighter conditions “are likely to weigh on economic, hiring, and inflation.”
In the press conference, Fed Chair Jerome Powell reiterated the Federal Open Market Committee’s stance that it is necessary to proceed “carefully,” but that it is not yet clear whether financial conditions are restrictive enough to drive inflation to the Fed’s 2% target. He also noted that he believes that while it is “gratifying” that we have not experienced more meaningful economic deterioration, a softer pace of growth and a softer labor market are likely necessary to get inflation anchored to the Fed’s target.
While there were no changes from a policy perspective, the economic backdrop has shifted markedly over the past three months. Capital markets suffered losses once again in October, as earnings failed to deliver the boost that investors enjoyed in April and July. In addition, despite the flaring of geopolitical tensions in the Middle East, the longer end of the Treasury curve remained stubbornly close to the 5% mark as concerns about debt sustainability and a higher-for-longer stance kept bond investors anchored to the short end of the curve. Even oil prices, which by many accounts should enjoy a supply induced tailwind over the next several years, fell during the month as concerns about a global economic slowdown outweighed supply pressure and geopolitical concerns.
In terms of the Fed’s next move, maintaining a data dependent approach may prove troublesome in our view, as divergence in different measures is confounding central banks and investors alike. U.S. job openings and non-farm payrolls are still representative of an economy growing at a strong pace, but consumer confidence measures may point to concerns about higher prices into next year and U.S. manufacturing PMI pulled back once again in October. In addition, the Fed may be fearful that the longest lag could come in the form of rising borrowing costs as households and companies have yet to grapple on a wider scale with meaningfully higher interest rates, having locked in lower rates over the last few years.
In our view, perhaps the most important takeaway from the post-meeting press conference was that the Fed does not see the recent move higher in longer duration Treasuries as justification to forego another rate hike; nor do they see a recent surge in non-farm payrolls and consumer spending as rationale to change their economic projections. Decisions will continue to be made on a meeting-by-meeting basis, and while there has been meaningful progress in bringing inflation closer to target, progress will be “lumpy,” and the Fed is not yet ready to declare the fight finished. With that said, the probability of a rate hike in December has now fallen to 19.4% according to the CME FedWatch Tool and both stocks and bonds moved higher during the press conference – a sign that investors may be skeptical of Powell’s attempt to remain hawkish.
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