Key Takeaways from November FOMC decision

What happened?
The Fed decided to keep the fed funds rate at its current level.1 The language in the Fed’s announcement changed only slightly, including adding a reference to "tighter financial conditions."
That's an important recognition that recent increases in the 10-year US Treasury yield are doing some of the Fed's work for it.
The Fed also announced it will continue to maintain quantitative tightening at its current pace.
How have markets reacted?
There was a meaningful reaction in the bond market. (It is worth noting that the drop in rates began in the morning with the worse-than-expected ISM manufacturing PMI reading.)
The 2-year US Treasury yield fell materially to a level not seen since September 4th. US stocks moved higher.
Also, it is worth noting that during Fed Chair Powell’s press conference, the Atlanta Fed released its “Nowcast” current expectation that US gross domestic product (GDP) growth would be 1.2% in 4Q, which would be a lot lower than the 4.9% growth in GDP we saw in 3Q.2
These Nowcasts, which are running expectations based on available data, change regularly, but today’s lowered expectation for economic growth is an example of the lagged effects of monetary policy starting to show up.
Not only was the Fed’s dovish hold positive for Asian risk assets, the US treasury announcement also caused the US long end to ease off which gives local Asian currencies some breathing room.
The Bank of Japan’s less than expected yield curve control (YCC) tweak seems to have mitigated upward pressure on long end yields though contributed to a drop in the Japanese yen.
I believe the UST 10y has already hit a peak and is likely on its way down, helped by disinflationary forces and a Fed that is likely to cut rates instead of raise rates going forward.
This certainly gives Asian central banks such as Indonesia and Philippines, more wiggle room to hold rates instead of raise them.
What is our outlook on the situation?
This was a dovish Fed pause. Fed Chair Powell certainly reserved the right to hike rates again, but our takeaway is that the Fed is very likely done with rate hikes. Key points:
Powell echoed comments made at the Economic Club of NY two weeks ago: wage growth has moderated a lot, and its trajectory is consistent with 2% inflation over time. This adds to the case for a continued pause in December that turns into the end of rate hikes.
On the topic of a high 10-year US Treasury yield helping to tighten financial conditions and serve as a substitution for more rate hikes, Powell said he wants to see persistent changes in financial conditions that are material.
He said he wants to see higher longer-term rates not connected to expectations of higher fed funds rates – although he acknowledged that currently seems to be the case.
He also said he believes mortgage rates at current levels could have a rather significant impact on housing.
However, he tried to leave the door slightly open to more rate hikes by saying that he’s not sure financial conditions are restrictive enough to finish the fight against inflation.
Powell noted it takes time for the effects of monetary policy to show up in the economy, so the Fed slowed its rate hikes this year to give it time to assess.
This suggests a 'prolonged pause' going forward (which would, in the rearview mirror, represent the end of the rate hike cycle).
Powell was rather dismissive of the September ‘dot plot’ from the Fed which showed a rate hike in December and only two implied rate cuts for 2024, saying that “the efficacy of the dot plot decays over three months” and that it’s “not a promise or plan of the future.”
Powell made it clear that he is wedded to continuing QT at its current pace. Something has to give since he has said he wants to proceed cautiously - so that also suggests foregoing any more rate hikes.
What is our resulting investment strategy?
We anticipate volatility in the near term, especially given the continued possibility of a government shutdown in later November.
However, given that markets are starting to assume the Fed’s tightening cycle is over, markets may soon begin to discount an economic recovery to occur later in 2024 after a somewhat bumpy but brief landing.
In this environment, we expect a growing global risk appetite. We anticipate smaller-cap stocks and cyclical stocks will outperform.
We anticipate strong performance from investment grade credit and high yield bonds.
We expect international assets, especially emerging markets, to outperform US assets.
What are we watching out for? What are the risks to our view?
We expect the Fed to be data-dependent, especially focusing on inflation data, specifically core inflation, wages and expectations – rather more than being moved by the behavior of financial conditions.
The risk is that the lagged effects of monetary policy cause a recession in the US. This could then cascade to other parts of the world. This environment would favor defensive investment positioning.
Reference:
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1
Source: The Federal Reserve, as of November 1, 2023
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2
Source: The Federal Reserve Bank of Atlanta, as of November 1, 2023