As expected, the Fed raised interest rates by 0.75% last week at its September FOMC meeting. This was the third consecutive 0.75% rate increase, setting the new target range at 3% to 3.25%. For reference, the federal funds rate target range was 0.25% to 0.50% leading up to the first interest rate hike in mid-March. The decision to proceed with another large rate hike was driven by persistent inflationary pressures in recent CPI and wage reports and the Fed’s goal to bring inflation down to 2%. The Fed’s actions last week were not surprising after the August and September CPI reports. However, last week’s Fed comments were more hawkish than the last update. In June, the Fed forecasted the federal funds rate would reach 3.4% by the end of 2022 and 3.8% by the end of 2023 before declining to 3.4% by the end of 2024. With the September release last week, those estimates increased to 4.4% by the end of 2022 and 4.6% by the end of 2023 before declining to 3.9% by the end of 2024. Fed Chair Powell warned monetary policy needed to be “more restrictive or restrictive for longer.”
Interestingly, the 2-year Treasury yield jumped to 4.13% last week. However, a noticeable gap remains between the Fed’s 4.4% year-end federal funds rate projection and the current 2-year yield. It’s possible investors still don’t buy into the Fed’s hawkish projections, and that we are nearing peak Fed hawkishness.
We need to remember two key points: First, the Fed is making monetary policy based on the rearview mirror (past data). Secondly, Fed tightening historically operates with a lag. However, if we are at or near peak hawkishness, this does not necessarily mean the S&P 500 bottom has been set or is nearby. However, this could lead to a shift in narrative and, potentially, market sentiment. If this sentiment change occurs, we expect longer-maturity Treasury yields to peak and provide relief to long-duration assets. Growth stocks and long-duration bonds could outperform under this scenario. We also want to emphasize the market narrative needs to shift, and/or the final rate hike of the cycle needs to be expected for this to occur.
Positioning portfolios in the current environment remains difficult and frustrating. Our recent commentaries have discussed the market’s confusion and lack of direction. Inflation and Fed policy uncertainty leave the market vulnerable to rapidly changing narratives, and last week’s price declines are the most recent example. At times, performance trends can be based on speculation and emotion, not fundamentals and macro data. Probabilities change as the market narrative shifts.
Just a month ago, the S&P traded near 4,200 ahead of the Jackson Hole meeting. Inflation’s persistence, the risk of an extended tightening cycle and the prospect of weaker earnings guidance and revisions were catalysts for the recent sell-off.
In the meantime, we are here to help you navigate these difficult and volatile markets. We will continue to work to identify additional threats to the market and convey our observations.
Dennis P. Barba, Jr.
CEO & Managing Partner
Michael P. Finkelstein, CFA
- The Federal Reserve
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