This afternoon’s verdict by the Federal Reserve to keep its overnight rate target unchanged at 5.5% was not really a surprise, given the recent actions of other central banks (including the Bank of Canada) and heightened geopolitical tensions that have likely not yet shown up in the economic data. While the decision was widely expected, economists and market participants are still debating whether this is just a pause or truly the end of the tightening cycle.

 

Heading into the decision, there was an op ed column by former NY Fed President Bill Dudley that pointed out a risk that the Fed could be repeating the mistakes of the Arthur Burns Fed of the 1970s, where inflation was allowed to get out of control. As we know, this experience ultimately led to substantial tightening by the Volcker Fed, which led to a very hard landing.  Today’s decision therefore illustrated the narrow tightrope that Chair Powell and the FOMC had to walk.

 

 

Inflation has definitely moderated from the peak in 2022, but remains well above the Fed’s 2% target and that is why some believe this pause had to be put in a hawkish frame. In other words, the Fed needed to leave the window open to additional hikes into 2024 in order to achieve its inflation target. It did so in again referencing the need to “assess the extent of additional policy firming” and how the job market is still strong, even though it has moderated.  The balance to the statement was in the Fed’s comment that tighter financial and credit conditions are weighing on the economy and that it will take cumulative tightening into account when making future decisions.

 

Coming into today’s meeting, both equities and bonds were looking more well-behaved than you would expect, given the high level of uncertainty but the Fed’s comment on how tightening efforts have not yet shown up was taken as a statement that it is done with hikes. Ally and I have held to the view that we are at the end of this rate hike cycle and today’s statement doesn’t move us from that. That doesn’t mean there is no risk in this view that inflation becomes more entrenched, although re-engaging in tightening becomes trickier given that it is an election year. It is more likely that the Fed will just leave rates at these levels for an extended period of time and that will ultimate cool the economy off, with a recession not off the table. That will be a friendlier environment for investment grade corporate and government bonds.

 

On behalf of the Pyle Group, have a wonderful rest of the day.   

Andrew Pyle

 

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