Market Update

January 31, 2024

Fed Leaves Rates Unchanged

What’s important

• The Federal Reserve (the Fed) today unanimously voted to maintain the current policy rate (basis points, or bps), leaving the Fed Funds Target Rate unchanged at 5.25% to 5.50%. This continues to represent the highest target range in over 22 years, though this pause also represents the fourth consecutive meeting at which the Fed has declined to adjust its policy rate.


• The official statement had several changes; some of them were verbiage to better reflect economic data, but a crucial phrase strongly hinted at keeping rates on hold through March. Chairman Jerome Powell reiterated this by saying that a March cut is “not likely,” which supports our house view of the first cut taking place in May.


• The market reaction was fairly muted despite the hawkish tilt implied by the official statement regarding potential rate cuts at the upcoming March meeting.

Fixed income

• Rates markets have rallied strongly today, though the rally was largely seen this morning after the Employment Cost Index came in slightly lower than expected. After spending much of the past two to three weeks above 4.00%, the U.S. 10-year Treasury settled in between 3.95% and 4.00% for the duration of the press conference. Perhaps the only notable change was a quick 5-bp bump higher following Powell’s “not likely” statement on the likelihood of cutting rates, but otherwise rates were in a fairly narrow range for a Fed meeting.


• We remain defensive in our credit positioning but do seek to increase investment-grade exposure tactically and selectively in corporate bonds, with the expectation that spreads should be resilient over the next six months. We continue to favor higher in credit quality (as we expect credit spreads to leak wider on the expected economic weakness). We advocate shifting from cash to the two- to five-year area of the U.S. yield curve in order to take advantage of potential price appreciation as well as locking in an attractive carry yield in advance of broadly declining rates. Within tax-exempt markets, we believe that essential service municipals are better positioned for an economic downturn. We prefer active fixed income portfolio management, and fundamental credit selection will offer opportunities in these volatile times.

Equities

• Powell poured a splash of cold water on equities this afternoon as he made the case that the Committee appears unconvinced but increasingly confident that inflation is moving durably toward the Fed’s target while the labor market comes into healthy balance. Unfortunately for equities, especially more cyclical and rate-sensitive segments, Powell articulated the unlikelihood that incoming data will be sufficient for the Federal Open Market Committee (FOMC) to gain the level of confidence necessary to initiate a rate-cutting cycle by its March 19 meeting. The S&P 500 declined by approximately 50 bps immediately following that mention, ending the day’s session down by 1.5%. Equities with lower volatility, higher realized growth and larger size characteristics outperformed while higher beta, leverage and Value lagged.


• In our view, U.S. equities continue to enjoy a supportive backdrop given the encouraging refinement of monetary policy while the nominal growth outlook evolves in a positive mix-shift toward cyclical expansion. However, we caution that progress is unlikely to be linear, and we’d expect a sawtooth pattern of improvement. We expect that a period of cyclical expansion will help allow for some equity segments to emerge from the shadows of mega-cap leadership, with opportunities for certain pockets including those more sensitive to the U.S. growth cycle, such as Small Caps, to enjoy a mean-reversion toward higher levels.

Going forward

• As expected, there wasn’t much new news in this meeting, with the only real surprise from Powell being his “not likely” comment on a possible March cut. Other factors appeared to be moving rates throughout the day, and we do expect volatility to continue until the more important March meeting. Summary of economic projections, quantitative tightening update and a (not likely) cut discussion are all on the table.


• We believe that the Fed now has rates at a level to fight inflation, as policy rates are at a sufficiently restrictive level, and the Fed has indicated that it’s likely hold them there until inflation continues moving closer to its 2% target.


• As markets further struggle with a 5%+ terminal rate (the level at which the Fed is expected to stop raising interest rates), we expect pockets of volatility across equities and fixed income, especially as geopolitical risk remains elevated. We believe that the Fed will remain fully data dependent, and Powell reiterated that many times at his press conference. While December’s inflation data was stronger than expected, the overall direction gives the Fed leeway to continue to pause further rate hikes and look at rate cuts later this year.