By: Russ Kamp, Managing Director, Ryan ALM, Inc.
This is a recording. US interest rates are rising! Yes, US rates are rising. What shocking news! Fed Chairman Powell announced this afternoon that the US Federal Reserve was once again raising the Fed Funds Rate 75 bps to a range of 3.0% to 3.25%. This continues an aggressive path upward for US rates that began earlier this year as it became more apparent that inflation was not transitory. However, it has taken market participants a long time to come to grips with the Fed’s activity.
Following the FOMC meeting, Powell indicated that the Fed Funds Rate is likely to hit 4.25% by year-end 2022. Which would indicate to me a further 75 bps increase at the November meeting followed by another 50 bps increase come December. The Terminal rate for this interest rate hiking cycle is now forecast to be 4.625% at year-end 2023, which is 25 bps higher than what the market had previously forecast.
So much for a quick reversal in policy that would have US rates falling in 2023. Furthermore, Powell reiterated that “the chances of a soft landing are likely to diminish to the extent that policy has to be more restrictive,” But the alternative is worse, he added. “A failure to restore price stability would lead to greater pain later on,” Mr. Powell said. No one should be surprised by this stance, as Powell and the other members of the FOMC have been very consistent even if their message has fallen on deaf ears.
Furthermore, the Fed has slashed this year’s growth forecast to just 0.2% (Q4 to Q4) from 1.7%, and the 2023 forecast has been cut to 1.2% from 1.7%. Lower anticipated growth for the US economy can’t be good for jobs/employment… and the stock market. Will lower payrolls be enough to tamp demand for goods and services? Is a possible 4.625% year-end 2023 FFR high enough to dramatically impact our current 8%+ inflationary environment. Remember, it took significant real rates to thwart inflation in the early ’80s. We aren’t close to having real rates with the US 10-year Treasury only trading at a yield of 3.5% (3:45 pm).
Lastly, total return-focused fixed income strategies are getting destroyed in 2022 and it doesn’t appear that 2023 will provide much relief. Don’t use fixed income as a return-seeking instrument. Use bonds for the certainty of their cash flows. The matching of asset cash flows to liability cash flows will mitigate interest rate risk for that portion of the liability cash flow schedule. I don’t think that anyone’s crystal ball is particularly good so why guess as to the direction of rates?