The bar to STOP hiking is probably lower than the bar to CUT!
Written by Kevin Headland & Macan Nia
After the volatility that ensued following the recent stress in the banking sector, investors were paying very close attention to the Fed comments on March 22, 2023 to gauge whether the events of the past few weeks would impact their policy decisions moving forward.
Here are our team’s 3 big picture takeaways from the Fed meeting.
The Fed Is Near the End
- The market does not believe the Fed’s path over the next few years. While the 'terminal' rate is now more in line, the path for the rest of 2023 and into 2025 is substantially different. While Powell said, "the base case did not include cuts", the market's base case certainly does. Who’s right?
- The Fed has incorporated SVB events as an alternative form of tightening, with Powell saying he estimates the events have been roughly equivalent to 25bps via the lending channels which will tighten. He emphasized that he thinks financial conditions have tightened more than a lot of traditional "financial conditions indices". The message: if we see more banking stress, it reduced the need for that ‘last’ hike.
- The Fed appeared slightly less concerned about inflation, though of course emphasized there was more work to be done. Powell referenced that long-term inflation expectations are anchored for households, business, forecasters, and markets. That's important because if they start to move in the other direction, we could get another visit from Hawkish Powell and the ability to slow/pause from this point forward might narrow.
The decision and commentary did little to change our views. We continue to believe that the fed will be extremely cautious in cutting interest rates too soon unlike other rate cycles fearing a reversal in inflation.
For bonds, we are likely transitioning into phase II of our “three-phase approach to investing in bonds”, where beginning to embrace duration should be beneficial. The tightening of financial conditions over the last week has likely added to the expectation of an upcoming recession and the subsequent drop in yields that occurs historically. However, it has been important to take advantage of the recent volatility of the yield curve.
For equities, we are likely to experience short term volatility, as the market digests the ongoing fallout from regional banks and the potential ‘whack a mole’ price volatility across other areas of the market. As the economy digests the hikes from last year, we believe inflation will continue to trend lower (our view is 4% by the end of the year), and we believe that multiple expansion in the back half of this year in anticipation of the Fed cutting rates in 2024 will help propel markets higher in 2023. Stock selection will remain key.
In our view, today’s selloff is more of a knee-jerk reaction to Treasury secretary Yellen saying that they are not looking at expanding deposit insurance more than what was said by the Fed.
Kevin Headland & Macan Nia
Co-Chief Investment Strategists, Manulife Investment Management