The Federal Reserve Chairman has been relentless in recent weeks, banging the drum for “higher for longer” interest rate policy. This has begun to undermine the Treasury market despite generally supportive economic data including better Personal Consumption Expenditures (PCE) core inflation. The messaging is important as should it play out in the markets as things currently stand (with higher government bond yields and lower risk markets) it could quite easily undermine both consumer and corporate confidence leading to a recession and potentially, much lower inflation.
Market expectations had initially held steady following the September Federal Open Market Committee (FOMC) meeting, but yields have edged higher yet again – more in fear than in response to activity data which has been consistent with a slow-down and lower inflation. It is curious that Jay Powell has adopted this very hawkish tone given the Fed’s Beige Book was one of moderation as highlighted by these key passages from the overall summary:
“Contacts from most Districts indicated economic growth was modest during
July and August.”
“…other retail spending continued to slow, especially on non-essential items. Some Districts highlighted reports suggesting consumers may have exhausted their savings and are relying more on borrowing to support spending.”
“Job growth was subdued across the nation.”
“Most Districts reported price growth slowed overall, decelerating faster in manufacturing and consumer-goods sectors.”
Trying to read into their thought process presents multiple options for consideration:
- Option 1: The Fed may deliberately want a period of below trend growth to ensure a permanent return to 2% inflation – even if it risks a short sharp, outright recession.
- Option 2: Alternatively, they do mean it (i.e. they will keep rates high for the next 6-9 months) as they feel that the US economy can withstand this, but it will take longer to return to target inflation.
- Option 3: It is a bluff and inflation keeps easing to target, even with a soft-landing allowing them to gradually loosen policy into the second half of 2024. We are currently veering between Options 1 and 3, which is consistent with our asset allocation stance of being overweight bonds in a balanced portfolio. Even Option 2 is palatable for the overweight fixed income allocation.
To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q4 2023 here.