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As expected, the Federal Open Market Committee (FOMC) increased interest rates by 75 basis points (bps) at its November 2022 meeting, bringing the target federal funds rate to a range of 3.75% – 4.00%. There was no change to existing plans for reducing the size of the US Federal Reserve’s (Fed’s) balance sheet. The FOMC statement included a sentence acknowledging the lagged effect of US monetary policy on the real economy and inflation. During Fed Chair Jerome Powell’s press conference, he suggested that the terminal policy rate for this economic cycle might be higher than he assessed it to be in September, but also that the pace of rate increases will slow in December or early 2023.
The Fed signaled that it intends to slow the pace of rate increases at upcoming meetings and to maintain the policy rate at the higher terminal level for a prolonged period. Monetary policy typically operates with long and variable lags, and the full impact of recent policy tightening is likely not yet reflected in the real US economy. Additionally, the speed at which the Fed is shrinking its balance sheet is extraordinary and its effects on the real economy, financial stability, and liquidity conditions still unclear.
However, there are early signs that Fed policy tightening is starting to affect economic indicators. US home prices have decreased from their June peak, financial conditions have tightened somewhat, upward pressure on average hourly earnings has eased, and job vacancies may have finally topped out. All of this should give the Fed some comfort with regard to slowing the pace of rate increases going forward. The challenge for the Fed is that while the changes in these economic indicators may be reassuring, their absolute levels remain inconsistent with the Fed’s goals:
The pace of Fed rate hikes from here is likely to depend on the resilience of the labor market. To materially slow the pace, the Fed will need to see moderation in both wage gains and core inflation readings. At present, the labor force participation rate is 62.3%, a full percentage point below pre-pandemic levels, while the unemployment rate of 3.5% is half a percentage point below the FOMC’s longer-run estimate. The October Employment Situation Report, to be released this Friday, will provide insight into the strength of recent wage gains and the likely magnitude of the Fed’s policy move in December.
Additionally, the Fed is likely to remain attentive to market liquidity conditions, given the uncertain impact of quantitative tightening on market functioning. This is apt to be a higher priority following the recent instability caused by the rise in UK government bond yields, which prompted intervention by the Bank of England. Indeed, the Fed has recently released several papers related to financial market stability, including a consideration of “all-to-all” Treasury market trading and research regarding the relationship between monetary policy and financial market stability. While market volatility alone is unlikely to alter Fed policy, material market disruptions could impact the Fed’s balance-sheet reduction plans.
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Multi-Asset Outlook — A rocky road to recovery in 2023
Markets may be jumping the gun when it comes to expectations for a policy pivot and the likely risk-asset rewards. Members of our Investment Strategy team still see bumps in the economic road, though their outlook has brightened a bit when it comes to China and other emerging markets.
Could Japan face a UK-style pension crisis?
Investment Director Masahiko Loo explores the risks of Japan facing a UK-style pension crisis and identifies fundamental reasons that make Japanese pension funds inherently less vulnerable.
Take credit: Our five best credit market ideas for 2023
Fixed Income Strategist Amar Reganti highlights credit market opportunities that he expects to arise over the course of 2023, against a backdrop of slowing growth.
Navigating the new global economy in 2023
This executive summary distills the points of view of several of our 2023 Outlook authors. Discover the risks and opportunities they see as we enter a new economic and market regime.
High yield: Opportunity to pivot in 2023?
Our high-yield bond portfolio managers have a guardedly optimistic outlook on the market and believe security selection will be key to benchmark-relative outperformance in 2023.
Currency outlook: Nearing the end of USD exceptionalism?
Fixed Income Portfolio Manager Martin Harvey and Investment Communications Manager Jitu Naidu consider the present state of and outlook for the US dollar.
The Fed’s unenviable task for 2023
Fixed Income Portfolio Manager Jeremy Forster offers his forward-looking take on the Fed's comments and latest rate hike coming out of its December meeting.
Reality bites: Are equity markets too upbeat?
Cautious on global equity risk, Global Investment Strategist Nanette Abuhoff Jacobson suggests that investors favor higher-quality stocks and take a look at high-quality fixed income.
Why Europe could surprise in 2023
Eoin O’Callaghan and John Butler discuss the contrasting prospects of the Euro Area and the UK and why 2023 could bring positive surprises in the region.
Hidden in plain sight: Overlooked opportunities in investment-grade credit
Fixed Income Strategist Amar Reganti and Investment Specialist Geoff Austein-Miller highlight some relatively simple, straightforward ways to implement a positive view on high-quality corporate credit.
Multi-Asset Outlook — Higher rates for longer: What does it mean for markets?
For central banks, the inflation fight is on, but the policy and market responses will vary in the coming months. Nanette Abuhoff Jacobson and Supriya Menon discuss the implications for equities, bonds, and commodities.