INSIGHTS

On November 02, 2023

End of The Hiking Cycle?

The Federal Reserve (Fed) held the Fed Funds Rate at 5.25% to 5.5% at their November 1 meeting, the first time it has held rates steady for two consecutive meetings since the start of the hiking cycle in 2022. It was, nonetheless, widely expected by the market.

The central bank made slightly hawkish changes to its statement, characterizing the pace of the economy as “strong” rather than “solid” and job gains as having “moderated” rather than “slowed.” However, it did note that tighter financial (and not just credit) conditions will likely weigh on economic activity.

The Fed will continue to watch the consumer for signs of weakness

Economic growth remains resilient. Last week’s GDP (gross domestic product) report showed that the economy expanded at a 4.9% growth rate in the third quarter, with a particularly strong contribution from consumer spending (Figure 1).

Figure 1: Consumer spending was still strong, despite the Fed’s rate hikes

Source: Bureau of Economic Analysis, St Louis Fed, Insight, October 2023

Chair Powell characterized this economic strength as “surprising,” although he did note that wage growth appears to be slowing, despite continued tightness in the labor market. He characterized risks to the economy as “balanced.”

Higher long-dated yields helping the Fed

Despite continued economic resilience, financial conditions have tightened as the “lagged” impact of the Fed’s rate hikes continue to be felt. Rising yields at the long-dated part of the curve provided further confirmation of this (Figure 2).

Figure 2: Higher long-dated yields are encouraging for the Fed

Source: Insight Investment, October 2023 | Past performance is not indicative of future results.

Long-dated yields serve as the basis for a large proportion of lending in the real economy and the discount rate for financial market valuations.

Therefore, we believe the Fed is justified in taking a cautious approach to further rate hikes.

The Treasury helped alleviate concerns about a long-dated supply shock

Outside the Fed meeting, investors also closely watched the Treasury’s quarterly refunding announcement this morning.

The Treasury is tasked with financing the federal government’s widening deficit, at a time the Fed is stepping away as a buyer. U.S. Treasuries were also heavily issued in the aftermath of the summer’s debt ceiling standoff to replenish funds, stoking fears that this would need to be balanced with heavy bond issuance to ensure a mix of outstanding securities in line with the Treasury Borrowing Advisory Committee’s (TBAC) recommendations.

However, the Treasury announced a relatively modest increase in Treasury bond issuance until the end of Q1 2024 (which includes a slowdown in long-dated issuance) and ongoing issuance (Figure 3).

Figure 3: The Treasury announced a modest increase in bond supply, likely reducing risks of pricing dislocations

Source: Macrobond, Sifma, October 2023

TBAC stated it “supported meaningful deviation from the historical recommendation for 15–20% Treasury bill share” (the ratio will likely approach 22% at the end of the first quarter), offering the Treasury flexibility to meet its financing needs.

We had suspected the Treasury would take such an approach, given ample demand from U.S. money market funds for securities such as Treasury bills.

We believe that this announcement significantly reduces the risk of a market dislocation in long-dated bond yields from supply shocks.

The hiking cycle could be over

The Fed’s favored inflation measure, core PCE (personal consumption expenditures), is currently running at 3.7% year-on-year, close to the Fed’s year-end forecast of 3.3%. Although inflation will likely take time to slow toward the 2% target, we believe the Fed will be encouraged by the progress that it has made and the signs that its policy is successfully being transmitted into the real economy.

While the Fed will remain data-dependent, we suspect it has reached the end of its hiking cycle.

CRN: 2023-1102-11232 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily that of Advisors Asset Management, Inc. (AAM). AAM was not involved with the preparation of third-party articles linked to on this page and the opinions expressed in those articles are not necessarily those of AAM.

Any forecasts or opinions expressed herein are Insight Investment's own as of November 2, 2023 and are subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.