On Wednesday, the long-awaited (in market time, where data is traded day-to-day) Fed meeting ended and the Fed announced the policy action, or lack thereof, that resulted from the meeting. The Federal Open Market Committee (“FOMC”) announced that they were leaving the federal funds rate unchanged at 5.25-5.50%. The Federal Reserve, being the central bank of the United States, and the FOMC, as its policy group, has a daunting task – maintaining price stability while helping to promote maximum employment. At this point, the two might seem diametrically opposed as maximum employment can fuel inflation – one goal in opposition to the other goal. The Fed has been walking a tightrope with this situation as they have increased the federal funds rate to reduce inflation (maintain price stability) while trying to achieve maximum employment (which means economic full employment, or that level of employment that allows the country to remain productive and growing without being inflationary). Quite the conundrum, no?
The release also contained the following language:
“In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
The “extent of additional policy firming” gave the release a somewhat hawkish tone, as it implies the Fed might not be done raising rates – which has not been reflected in the federal funds futures market. Moreover, the projections by the FOMC members of the Federal Funds rate has increased slightly since the June meeting.
If the committee members’ projections are accurate, the median participant projects that the appropriate level of the federal funds rate will be 5.6 percent at the end of this year, 5.1 percent at the end of 2024, and 3.9 percent at the end of 2025. While the median projection for this year has not changed, it has moved up by 1/2 percentage point at the end of the next two years.
A summary of changes is:
- Longer run Fed funds median at 2.5% compares to previous forecast of 2.5%
- 2023 median Fed funds 5.6% vs 5.6%
- 2024 median Fed funds 5.1% vs 4.6%
- 2025 median Fed funds 3.9% vs 3.4%
The table below evidences this:
Source: Federal Reserve
In short, the Fed has once again told the market “higher for longer”. As of yet, the market has refused to listen and price things accordingly. To this end, we see the following federal funds expectations contained within the federal funds futures – note they reflect a cut by mid next year and ending the year nearly 50 basis points (0.50 percent) below the FOMC projection of 5.10 percent. The table below shows the rate implied by federal funds futures and the changes over the last month.
The path of federal funds graphically now and over the last month:
We continue to believe that absent some form of systemic shock, any rate cut will occur in the latter half of next year at the earliest. Ultimately, the contraction in credit and a higher funds rate should slow the economic train down, but hopefully not stop it. Consumer and business balance sheets are in decent shape, which is what has maintained a higher level of spending and kept the economy chugging along (as also evidenced in the FOMC projections of 2023 GDP, which has increased significantly since the June 2023 meeting). We do believe that the ability to keep spending in this fashion will become strained as savings are further reduced, and debt is used.
The bottom line is that we believe the market is still not reflecting a “higher for longer” federal funds regime, and as such, risk assets (such as stocks) are expensive and at risk of a retreat/repricing. As always, a portfolio of diversified assets helps reduce the potential negative impact of any one asset class and helps investors progress towards their financial goals. If you have any questions please reach out to your financial advisor.
The views stated in this blog (report) are not necessarily the opinion of Cetera Advisors LLC. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.