Key takeaways
- As it has since late 2023, the Federal Reserve continued to hold the line on interest rates at the March 2024 meeting of the Federal Open Market Committee.
- It marks the fifth consecutive meeting with no change to interest rates after raising rates eleven times between 2022 and 2023.
- Fed officials currently anticipate three rate cuts coming later in 2024.
In a move anticipated by investors, the policy making Federal Open Market Committee (FOMC), at its March 2024 meeting, held the line on the short-term federal funds target rate it controls. As it did in its previous four meetings, the FOMC maintained the target rate in the range of 5.25% to 5.50%. Although Federal Reserve (Fed) officials indicated in late 2023 that it would begin cutting interest rates this year, the timing of its initial rate cut for the current cycle remains in question. That leaves the fed funds target rate at its highest level since 2001.
Source: U.S. Federal Reserve, March 20, 2024.
After the FOMC’s March 2024 meeting, a report released by its members continued to project three cuts to the fed funds rate this year.1 This was generally in line with previous FOMC projections, and reassured investors that rate cuts remained on the Fed’s agenda. What’s less clear is the timing of those rate cuts. “Inflation remains a bit sticky, and the Fed realizes that once they start with rate cuts, it is hard to stop doing so in future meetings,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. In a statement released after its March meeting, Fed Chair Jerome Powell stated, “The Committee does not expect it will be appropriate to reduce the (fed funds) target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”2
Inflation, as measured by the Consumer Price Index, stood at 3.2% in February.3 The most recent release of a closely watched Fed inflation measure, the core personal consumption expenditures (PCE) index, was 2.8% higher at the end of January than the previous year, its lowest reading in almost three years.4
Market reacts to Fed policy moves
After the Fed first indicated, in late 2023, that fed fund rate cuts were on the table, markets initially priced in the first rate cut for the Fed’s meeting in March 2024. Powell dismissed that likelihood in comments offered after January’s FOMC meeting.5 As inflation hovered well above the Fed’s 2% target, markets exhibited nervousness about whether the Fed might scale back its stated rate cut plans. However, with FOMC projections clarifying that the Fed still anticipates making three rate cuts in 2024, based on current information, equity markets initially reacted favorably. The S&P 500 moved nearly 1% higher in the hours after the Fed’s March announcement. Notably, the FOMC did scale back rate cut projections for 2025.
“Despite its progress since early 2022, current inflation is still above the Fed’s target rate. But we think the Fed will have to start cutting rates before inflation drops to the 2% level,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management.
Inflation’s stickiness
A primary Fed focus since 2022 was to temper the rapid rise in the cost of living. Headline inflation, as measured by the Consumer Price Index (CPI), peaked at 9.1% for the 12-month period ending in June 2022, but dropped significantly since, with declines moderating in recent months.3
Source: U.S. Bureau of Labor Statistics. As of Feb. 29, 2024.
“The Fed has had opportunities to change its 2% annual inflation target, and it hasn’t done so,” says Freedman. “Despite its progress since early 2022, current inflation is still above the Fed’s target rate. But we think the Fed will have to start cutting rates before inflation drops to the 2% level.” In fact, the FOMC’s projections indicate its expectations are that inflation will remain above 2% in 2024 and 2025, but the FOMC still anticipates rate cuts over those two years.1 Freedman says the Fed must be cognizant of reducing the current fed funds rate from its current high level before it starts causing damage to the pace of economic growth.
Haworth agrees, noting that the Fed may eventually feel increasing pressure to begin cutting rates. “Now that inflation has dropped, the current fed funds rate is higher on a real (after-inflation) basis than it was back when inflation was 9%.” Haworth adds that “at some point, the Fed may feel it’s being tougher on the economy than it really needs to be.”
Reducing the Fed’s balance sheet
Haworth also anticipates that the Fed may scale back its “quantitative tightening” strategy. This approach has seen the Fed reduce its bond holdings since mid-2022, currently, at a rate of $95 billion per month. “At some point, the Fed may consider slowing the pace of their tapering,” says Haworth. “Though in terms of the market’s response, such a move probably has less impact than a decision to start lowering the fed funds target rate.” The Fed’s balance sheet of asset holdings grew to just under $9 trillion in early 2022. It’s now dropped to close to $7.5 trillion.6 While the Fed intends to continue reducing its balance sheet for now, Fed Chair Jerome Powell said in March that “it will be appropriate to slow the pace of runoff (balance sheet reduction) fairly soon, consistent with the plans we previously issued.”
Source: Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets (Less Eliminations from Consolidation), retrieved from FRED, Federal Reserve Bank of St. Louis. As of March 13, 2024.
The U.S. economy holds its ground
Despite significant Fed monetary tightening, the U.S. economy remains resilient, and it appears that the Fed expects growth to continue. That includes an upgrade to anticipated 2024 economic growth as reflected in Gross Domestic Product (GDP). In December, Fed members projected 2024 GDP growth of 1.4%, but have now raised their projection to 2.1%. In addition, it sent encouraging signals on the labor front, anticipating fairly stable conditions. The FOMC projects employment at 4.0% for the year, not far from the most recent reading of 3.9%.1 While wage growth has been one driver of inflation in recent times, Powell stated in March that “wage increases have been quite strong, but they are gradually coming down to levels that are more sustainable over time,”2 indicating the Fed sees a diminishing inflation threat from current wage growth trends.
Role of the Fed
Congress’ mandate for the Fed is to maintain price stability (manage inflation); promote maximum sustainable employment (low unemployment); and provide for moderate, long-term interest rates. Fed monetary policy influences the cost of many forms of consumer debt such as mortgages, credit cards and automobile loans. While Chair Powell receives much of the attention, the FOMC establishes Fed monetary policy, setting the fed funds target rate and the buying and selling of securities.
Will the investment environment change?
With the market continuing to anticipate the Fed easing monetary policy later in 2024, what does it mean for investors? Today’s market appears to offer opportunities to return to more neutral portfolio positioning. Here are potential moves that may be appropriate for a diversified portfolio given the current environment:
- Fixed income market. Although bond yields have slipped from their peak, interest rates remain elevated compared to the environment prior to 2022. That makes fixed income securities more attractive. While higher yields can be earned in short-term debt instruments, it’s important to also consider longer-maturity U.S. Treasuries as well to help support portfolio diversification. “You don’t want to invest just with a 30- to 90-day outlook,” says Haworth. “You want to look at what’s going to work more effectively to help you meet your long-term goals.” Haworth notes that there’s strong investor sentiment toward corporate bonds, municipal bonds (for tax-aware investors) and collateralized loan obligations. “These types of securities offer a way to enhance yields, and from a quality standpoint, they are holding up fairly well in the current economy,” says Haworth. Within certain non-taxable portfolios, explore a meaningful investment in non-government agency residential mortgage-backed securities. Trust portfolios may consider reinsurance to capture attractive income with low correlation to other portfolio components.
- Equity markets. In early 2024, stocks retained the upward momentum that emerged in 2023’s closing months. Markets are clearly playing a Fed rate cut waiting game. “The high interest rate environment is taking a toll on utilities and real estate stocks, which benefit from lower rates,” says Haworth. “The rest of the market seems to be benefiting from generally positive economic data.” Although the markets are likely to face some choppiness in the near term, Haworth says investors should not hesitate to put money to work in equities. “Investors who have assets to deploy in the stock market may wish to consider dollar-cost averaging over a period of time (consistently investing over at least a six-month period).” This systematic investment approach has the potential to mitigate risks during volatile market periods, while still positioning assets to meet long-term goals.
Be sure to consult with your financial professional to review the positioning of your portfolio to determine if changes might be appropriate given your goals, time horizon and feelings toward risk given today’s evolving interest rate environment.
Article source: usbank.com
