The Federal Open Market Committee (FOMC) meeting ended Wednesday with another pause, and it would be easy to assume that the data releases and Chair Powell’s press conference went exactly as expected. But, as any of us who have been around for more than a few decades knows, nothing in life is that simple. And it is particularly arduous when we’re talking about the Fed. So what did they do now?
Markets overwhelmingly predicted the decision to hold policy rates at 5.25%-5.50%, and the Fed members unanimously supported it. However, it was the Summary of Economic Projections (SEP) that drew all the attention. As a reminder, the SEP is an aggregation of the projections from the meeting participants, which shows their estimates of the most likely outcomes for real gross domestic product (GDP), the unemployment rate, and inflation (measured by the personal consumption expenditures index) for the coming years.
It is fundamental to understand what Powell said in his press conference; “remember that, of course, the SEP is not a plan that is negotiated or discussed as a plan. It’s an accumulation, and what you see are the medians. It’s an accumulation of individual forecasts from 19 people.” You’ll note that he makes sure to mention it is not a plan but rather an indication of where the individual members think policy will move given the estimated economic indicators. And while it isn’t a “plan” per se, it’s about as close as you can get, and the market indeed uses it as such.
Due to that, it’s important to understand what changed and why the equity markets have reacted so poorly. As you can imagine, this is not always easy or straightforward. And on its face, many of the estimates for 2023 show what should be great news:
– GDP: +2.1% vs. 1.0%
– Unemployment: 3.8% vs. 4.1%
– Core PCE: 3.7% vs. 3.9%
*September vs. June SEP
With a more robust economy (higher GDP), a more vital consumer (lower unemployment), and less inflation (lower Core PCE), you might expect the markets to rally. And all else equal, that could have been the case this time. However, all else was not equal, as one other adjustment to the SEP caused the backlash.
And what was the change? It was a fairly sizeable increase to the “projected appropriate policy path” for the Federal funds rate. According to the most recent report, the appropriate policy rate increased by 50 basis points in 2024 and 2025, meaning rates could be higher for longer than expected. For 2024, that implies an end-of-year range between 5.00%-5.25%, which would only be one rate cut from where we stand today. Given this more hawkish projection, equities have reacted negatively, and fixed-income yields have continued to increase.
But just because all of this data is in the report, does it mean the Fed will follow the script? We know Chair Powell was keen to note that the SEP is not a plan. In addition, the track record of FOMC actions versus what is in the SEP is not highly correlated. So perhaps, by indicating a potential final rate increase, Federal Reserve officials maintain their flexibility to adjust rates upward if inflation surges or the job market remains robust. It’s simpler to withdraw this option later than to eliminate it now and potentially reintroduce it later. Forecasting this possible rate hike also preempts investors from questioning when the Fed might reduce rates. The concern is that if investors shift to this line of thinking, rate expectations could drop significantly, lowering long-term interest rates and inadvertently giving the economy an uplift that the Fed isn’t ready to provide.
Economy
- It was another challenging week for U.S. equity markets, with the S&P 500 down -2.9%, the Nasdaq down -3.6%, and the small-cap Russell 2000 down -3.8%. The news of the week was the Fed meeting and the accompanying hawkish Summary of Economic Projections, which drove the declines.
- Housing starts in the U.S. sank 11.3% MoM to a seasonally adjusted annualized rate of 1.283 million in August, the lowest level since June 2020 and well below forecasts of 1.44 million. Tighter financial conditions, a surge in mortgage rates, and high home prices continue to weigh on buyers’ affordability.
- The average interest rate for 30-year fixed-rate mortgages with conforming loan balances ($726,200 or less) in the U.S. rose by 4bps to 7.31% in the week ended September 15, 2023. Borrowing costs came back to 23-year highs hit in August.
- The number of Americans filing for unemployment benefits plummeted by 20K to 201K on the week ending September 16, the lowest since late January and well below market expectations of 225K. Meanwhile, continuing claims fell by 21K to a near eight-month low of 1,662K, indicating the unemployed are having an easier time finding new work.
Stocks
- U.S. equities were in negative territory. Consumer Discretionary and Real Estate led the decline, while Healthcare and Utilities outperformed. Value stocks led growth stocks, and large caps beat small caps.
- International equities closed lower for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield increased 12 basis points to 4.44% during the week.
- Global bond markets were in negative territory this week.
- Corporate bonds led for the week, followed by government bonds and high-yield bonds.
