- Fixed Income Portfolio Manager
Skip to main content
- Funds
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Following four consecutive 75 basis-points (bps) increases to its policy rate, the Federal Open Market Committee (FOMC) finally slowed the pace of its rate-raising campaign, with a 50 bps hike at its December meeting — a move that had been widely anticipated by most observers.
Despite the smaller rate increase, the FOMC signaled that monetary policy might need to be even more restrictive in 2023 than it had projected this past September, with its policy rate likely going higher than what’s recently been reflected in market prices. Although the November inflation print showed further deceleration, US Federal Reserve (Fed) Chair Jerome Powell suggested that the FOMC will need to see “substantially” more evidence that inflation is continuing to drift lower — which could take several months or more of encouraging data — before the Fed would be willing to pause its rate-hiking cycle.
The annual US headline inflation rate, as measured by the Consumer Price Index (CPI), moderated to 7.1% year over year in November 2022 — its lowest level of the year — helped by a sharp decline in the energy components of the index. Core inflation also fell more than expected, to 6.0% year over year.
A significant drop in core goods prices accounted for the bulk of the easing inflation, while core services prices have proven “stickier” due to the shelter component remaining quite elevated relative to history. However, most of the leading indicators I track suggest that house prices will come down over the next six to 12 months. Even so, my base case right now is for US inflation to end 2023 above the Fed’s target, which would make it exceedingly difficult for the Fed to justify the interest-rate cuts the market has been pricing in.
I suspect the Fed will lift its policy rate to a terminal level of around 5% by the first quarter of 2023 and then go “on hold” to ensure that monetary policy remains restrictive enough to keep pushing inflation lower.
Thus far, the labor market has been quite resilient in the face of Fed policy tightening, but that will need to change before the Fed can even consider cutting rates. Unfortunately, that probably means the US unemployment rate will need to rise by more than the Fed is currently forecasting in order to achieve enough demand destruction to bring inflation down sufficiently.
As of this writing, I maintain a bias for the US Treasury yield curve to continue to flatten from here. Most fixed income investors are well aware of the heightened risk of an economic recession next year, with many proclaiming it would be the most well-telegraphed US recession of all time. If the Fed prematurely waves the “all-clear” flag and begins to cut rates with inflation still perched above its target, inflation could quickly reaccelerate, damaging the Fed’s inflation-fighting credibility in the process.
Bottom line: I’d say the Fed has a tough and unenviable task ahead of it.
Expert
June FOMC meeting: May disinflation is welcome, but is not enough for a rate cut
Continue readingGovernments have been slow to reduce their fiscal deficits — it could cost them
Continue readingURL References
Related Insights
When the Fed sneezes, the ECB… cuts rates regardless?
Since the late 1990s, when the US cycle turned, the rest of the world generally followed, with a lag. However, the new economic era is likely to result in greater cyclical divergence between countries and the need for different central bank responses. How should investors think about the age of economic divergence?
June FOMC meeting: May disinflation is welcome, but is not enough for a rate cut
Fixed Income Analyst Caroline Casavant discusses what June's FOMC meeting tells us about the US Federal Reserve’s latest thinking on interest-rate cuts.
The revenge of the monetarists
Fixed Income Portfolio Manager Brij Khurana makes the case for a monetarist explanation for moderating inflation.
Governments have been slow to reduce their fiscal deficits — it could cost them
Our expert explores the investment implications of continued excessive deficit spending by G7 countries.
Powell back to waiting on inflation data
Our expert's key takeaways from the May FOMC meeting.
The Fed’s lessons learned from its COVID response
Fixed Income Portfolio Manager Brij Khurana breaks down the central bank's policy decisions during the pandemic and explains how they continue to affect financial markets.
FOMC: Stable policy amid market volatility
The Fed is holding steady amid market turmoil. See our quick notes on the FOMC's March policy statement, forecasts, and the Fed chair's press conference.
Is the US economy really that different since COVID?
US economists have been touting the resilience of the post-COVID economic rebound. Brij Khurana dissects several key economic indicators to see what's really changed since 2019.
Income: the hard worker in your portfolio deserves more credit
Income from cash is good but income from bonds is better. In a less certain macro environment, Alex King, Supriya Menon and John Mullins think the case for income only gets stronger. How can investors make the most of opportunities?
The shifting liquidity landscape: What’s at stake?
The beginning of the end could be in sight for the Federal Reserve’s quantitative tightening (QT) program. US Macro Strategist Juhi Dhawan considers the Fed's next steps and what they could mean for banks, liquidity, and markets broadly.
URL References
Related Insights
Japan equity: Reason to believe
Our expert argues that corporate governance reform and the Japanese economy's escape from persistent deflation have laid the groundwork for a sustainable equity rally.
By
Toshiki Izumi, CFA, CMA