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Markets and Economy
When doves yell: Fed loudly signals a September rate cut
Minutes from the July FOMC meeting were surprisingly dovish, and Federal Reserve Chair Jay Powell suggested a likely policy shift in comments from Jackson Hole.
The U.S. Federal Reserve hiked rates by 25 basis points at its May meeting in a unanimous decision.
Despite the Fed Chair’s protests, this appears to me to be a de facto “conditional pause.”
We anticipate elevated market volatility in the near term as there will be even more scrutiny of the data going forward.
The U.S. Federal Reserve (Fed) hiked rates by 25 basis points in a unanimous decision today. Importantly, I believe this appears to be a de facto “conditional pause” even though Chair Jay Powell insisted “a decision on a pause was not made today.” Here’s why:
In addition, the Fed has not changed its quantitative tightening policy.
Stocks fell, with value stocks down more than growth stocks. The Russell 2000 Growth Index modestly rose on the day. Gold rose, as did the VIX. U.S. Treasury yields fell. The KBW Regional Banking Index fell again today, although it experienced a modest rebound late in the trading day.1
We anticipate elevated market volatility in the near term as there will be even more scrutiny of the data going forward to see whether it will trigger additional rate hikes. But the key takeaway, in my view, is that we are likely at or very near the end of the rate hike cycle. This is likely to pave the way for more supportive conditions for risk assets such as equities. Stocks, for the most part, have tended to perform well in the one to two years after rate hikes, with the exception of 2000.2
Given our expectations for near-term volatility — exacerbated by uncertainty around Fed policy, concerns about the U.S. hitting the debt ceiling, and fears of more issues with regional banks — I would favour defensive portfolio positioning. However, we would anticipate an improving global risk appetite once these issues are resolved.
There is a risk that this rate hike and continued quantitative tightening may place additional pressure on certain banks.
There is a risk that once the cumulative effects of monetary policy tightening are fully felt by the economy, they may be significant enough to cause a substantial recession.
There is also a risk that future data could suggest stubborn elevated inflation, which would likely cause the Fed to hike rates again.
It is worth noting that the tension between the risk of stubborn core inflation and the opposite risk of cumulative contractionary pressures from rate hikes and quantitative tightening may leave the Fed in a conditional pause with a neutral bias for some time. This in turn could prolong policy uncertainty and market volatility, pending greater clarity on the banking stresses, and the speed and extent of disinflation.
We will be watching the regional banking situation, economic data, and inflation data closely.
With contributions from Paul Jackson, Adam Burton, Arnab Das, and Brian Levitt
Central banker quotes from the Federal Reserve and the Bank of Canada.
Source for performance statements in this paragraph: Bloomberg, L.P., as of May 3, 2023. Value stocks represented by the Russell 3000 Value Index. Growth stocks represented by the Russell 3000 Growth Index.
Sources: U.S. Bureau of Labor Statistics and Bloomberg, L.P., as of 5/3/23, based on S&P 500 Index performance in the 1- and 2-year periods following peak inflation in February 1970, December 1974, March 1980, December 1990, and July 2008.
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Important information
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Some references are U.S. centric and may not apply to Canada.
Past performance is not a guarantee of future results.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
All investing involves risk, including the risk of loss.
An investment cannot be made directly in an index.
A loan loss provision is an accounting measure that is used to cover uncollected loans and loan payments.
The Federal Open Market Committee (FOMC) is a 12-member committee of the Federal Reserve Board that meets regularly to set monetary policy, including the interest rates that are charged to banks.
Tightening is a monetary policy used by central banks to normalize balance sheets.
A basis point is one hundredth of a percentage point.
The KBW Regional Banking Index is a float-adjusted, modified-market-capitalization-weighted index that seeks to reflect the performance of publicly traded companies that do business as banks or thrifts in the US.
The Russell 2000® Growth Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of small-cap growth stocks.
The Russell 3000® Value Index is an unmanaged index considered representative of the U.S. value stocks. The Russell 3000® Growth Index is an unmanaged index considered representative of the U.S. growth stocks. Both are trademarks/service marks of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co.
The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
The opinions referenced above are those of the author as of May 3, 2023. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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