The good, the bad and the ugly: Key takeaways from the November Fed meeting
The U.S. Federal Reserve (Fed)—as expected—delivered another supersized 75-basis-point (bps) rate hike at Wednesday's meeting, bringing the federal funds rate to a target range of 3.75%-4.0%. Investors were more focused on what Chair Jerome Powell might signal about the pace of rate hikes and the level of interest rates that will be needed to bring inflation back down to target. On this front there were a number of competing developments that drove volatility throughout the meeting.
Key takeaways from the Fed meeting and Powell press conference
- There was a greater emphasis on the large rate hikes that the Fed has already delivered, with an emphasis that these increases will take time to slow down the economy and bring inflation back to 2%. Relative to previous comments from Powell and other Federal Open Market Committee (FOMC) participants that they needed to see “clear and convincing evidence that inflation is coming down”, this marked a potential shift to a more balanced and forward-looking monetary policy strategy. Overall, this was a dovish signal.
- Powell indicated that the Fed would consider slowing down the pace of rate hikes at its next meeting in December or at the following one in February 2023. Our baseline had been for a stepdown to a smaller 50-basis-point rate hike in December—and markets were already pricing in a significant possibility of this outcome. So, this was in-line with expectations, but with clearer guidance that big 75 basis-point (bps) moves are likely coming to an end.
- Powell discussed his own interpretation of recent economic data—notably the resilience of the labor market and the hot inflation readings—and concluded that the peak federal funds rate will now likely need to be higher than what the Fed previously forecasted in September (4.5-4.75%). Again, markets had already repriced to these levels ahead of the meeting, but Powell’s emphasis on the level of interest rates and revising his own outlook higher was hawkish.
Fed will still hike rates into restrictive territory
While the 50-or-75 debate grabs headlines, the main message here is that the Fed will still be hiking interest rates to the point that monetary policy is meaningfully restrictive. A restrictive monetary policy, by design, is meant to slow the economy down, bring supply and demand back into balance, and—through that—ease inflationary pressures. None of that has changed.
How did markets react?
U.S. Treasury yields moved slightly higher following the meeting and equities—as measured by the S&P 500 Index—lost ground.
At Russell Investments we are carefully weighing these economic risks against evidence that market psychology is very pessimistic. We believe our clients should maintain a balanced portfolio strategy through the erratic down/up/down/up equity price action in recent months. At the asset class level, U.S. Treasury yields have now risen considerably across the curve and likely offer attractive value for investors, in our view.
For example, Treasury yields now trade well in excess of expected inflation across the curve. Positioning data suggests speculative investors are already very short bonds, creating a potential positive asymmetry to future fixed income returns. And with recession risks elevated, we believe bonds have an important diversifying role to play in portfolios. Case-in-point: History suggests that yields, particularly out to the 5-year point of the curve, tend to fall historically from the peak to the trough of the business cycle.