Weekly Wisdom – September 21, 2023

By Hightower Great Lakes on September 21, 2023

Fed Holds Rates Steady, Hints at Further Hikes

The Fed unanimously voted to hold rates steady at 5.50% at the September 20 meeting. The decision does not come as a surprise and has been well telegraphed by Fed speakers in the weeks prior to the meeting. Powell’s remarks mirrored his hawkish stance at the recent Jackson Hole Symposium in late August.

Despite higher-than-anticipated inflationary data released since the last FOMC meeting on July 26, the readings were not sufficiently high to warrant another hike. Following the release, the U.S. 2-year Treasury yield spiked to 5.14%, the highest level since 2006.

During his press conference, Fed Chairman Powell noted that price stability remains the most important facet to a well-functioning economy, and that a failure poses the greatest threat. In other words, the Fed’s 2% inflation target remains its goal, with no room for movement higher.

While tightening began 18 months ago in March of 2022, the full effects of tightening are yet to be felt, however, the FOMC committee does believe that 5.50% is a sufficiently restrictive policy.

The FOMC statement did include one marked change from the prior release, stating the U.S. economy is expanding at a “solid” pace versus prior use of “moderate” growth. Fed Chairman Powell noted that consumer spending remains “robust,” which is displayed in the Atlanta Fed’s GDPNow tracker Q3 estimate of 4.9%, well above the 2% long term trend, and an acceleration from 2.4% in Q2.

This is consistent with what we have been saying throughout the year. The economy has momentum led by the strength in the consumer and pockets of momentum in the manufacturing sector driven by the 2 trillion dollar infrastructure stimulus on the fiscal side of the economy. 

The FOMC released its dot plot, which remained unchanged for 2023, however, the longer-term 2024 and 2025 rate projections each rose by 50 bps, reflecting our belief of “higher for longer” in the interest rate path. While we are in the ninth inning of the current hiking cycle, higher rates will continue as long as economic growth remains above trend and inflation remains persistent. We believe there is no reason for the Fed to cut rates given the unexpected strength the U.S. economy has shown.

Chart 1: Updated FOMC Dot Plot[1]

Powell noted the continued strength of the labor market. One of the Fed’s most watched indicators, initial jobless claims, has steadily crept lower since peaking at 265,000 in June, and the four-week moving average now stands at 223,000 – well below the recessionary average of 350,000-375,000 seen in Chart 2 below.

The Federal Reserve’s dual mandate for price stability and maximum sustainable employment remain at odds with each other given the continued strength in consumer spending.

Chart 2: Initial Jobless Claims During Recession[2]

While the prospect of a soft-landing remains the Fed’s primary objective, Powell noted that a soft landing is not the baseline assumption at this point. The Fed’s main goal to return inflation to the historic neutral rate of 2% remains dependent on incoming data as well as the recent increase in energy prices, which presents an obstacle to consumer confidence.

As indicated in Chart 3, both headline and core CPI levels have fallen in tandem with the aggressive increase in the lending rate. However, as noted earlier, higher readings since the July 26 meeting have somewhat put the Fed on its heels.  

Chart 3: U.S. Headline and Core CPI vs. U.S. Target Rate[3]

Global Monetary Policy

With the exception of Japan and China, central banks around the world have been raising their policy rates for more than a year. On the morning of September 20, we received key policy rate data from Great Britain. This data showed that the core inflation rate came in at 6.2% y/y, below expectations of 6.9%, and a sharp deceleration from the prior month’s reading of 6.9%.

Following the release, traders lowered the probability of a 25 bp rate hike to 50%, providing further evidence that the central banks who are raising rates are making continued progress against inflation. The opposite is true for Japan and China. The BOJ is being patient and sticking to its current stimulating policy despite inflation running over its 2% target for 17 months in a row.[4]

China is the only major country cutting rates and we are seeing green shoots in economic data – better industrial production and retail sales that doubled prior results. GDP in China is expected to be 4.5% and we believe it is poised to move higher throughout the year following several monetary policy steps to re-inflate its economy.[5]

Chart 4: Global Central Bank Lending Rates

Click here to read last week’s Weekly Wisdom (9/15).

Disclosures

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This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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[1] Source: Federal Reserve. As of September 20, 2023.

[2] Source: Bloomberg. As of September 20, 2023.

[3] Source: Factset. As of September 20, 2023.

[4] Source: Reuters. As of September 14, 2023.

[5] Source: South China Morning Post. As of September 11, 2023.