Will they or won’t they? For anyone left wondering about what lies in store for Federal Reserve rate policy after last week’s FOMC meeting, it was the press conference following the statement release that was the main show. After months of waiting to see whether the Fed’s aggressive rate hikes might be nearing their end, Fed Chair Powell put the kibosh on the need for any further guesswork. Mr. Powell spoke pretty plainly about the path ahead for the Fed Funds Rate in 2023 and beyond. I see three clear takeaways from his remarks:
There’s no Fed pivot coming anytime soon. For those who had hoped that we all might find an easy way out of the present inflationary environment and an end to rate hikes in the nearer term, that now seems far less likely. At best we may start to see a slowdown in the pace of the hikes over the coming months. The Fed’s message is clear, despite slowing economic data, there are more hikes to come.
While the pace of the hikes may slow, the Fed funds terminal rate will likely be higher than where we thought it would be as recently as this past September. In his remarks, Mr. Powell suggested that the terminal rate would be higher at the end of this cycle than where the market had previously anticipated. In fact, we believe that these remarks were designed to prepare people for the long-term expectation that the terminal rate will settle in at a higher level than it has in the past 25 years. We believe the peak for Fed Funds will likely come in Q2 near 5%, and that the terminal Fund Rate will have to remain higher than the 2.0 – 2.5% range many believe to be the Long Term rate.
Rates will need to stay higher for longer. While there’s no crystal ball, it’s clear now that rates will need to stay higher for longer. We should no longer expect an aggressive easing. In fact, the Fed has been consistently saying for several months not to expect much easing in 2023, and Mr. Powell reiterated that in his remarks. The structural changes in our economy that are keeping inflation higher all remain stubbornly in place. As we’ve written previously, these factors range from the De-Globalization of trade, Western Demographics, and runway energy prices, due, in part to the ongoing war in Ukraine and the persistently strong employment numbers. What’s currently priced into the market is for the Fed Funds Rate to be at 4.43% in December of 2022 and at 4.89% in December 2023. Since peak will likely come in Q2 2023, it seems possible that the Fed will do only one ease in 2H 2023.
In his remarks, Mr. Powell also admitted that the Fed’s actions to-date have had little effect in combatting the CPI. The bottom line as we see it is that Mr. Powell has effectively admitted that the window for a soft landing is closing. Recession may lie ahead.
What does this mean for investors? The MOVE Index remains elevated. Currently it stands at 136 compared to an average of 112 over the past year and an average of 130 over the past six months. In just the month leading up to last week’s FOMC, the MOVE was as high as 160. So the one certainty in all of this is that there remains significant volatility around inflation and economic growth. We continue to believe that hedged strategies can be beneficial for generating alpha and uncorrelated returns to the directional macro markets.