Key takeaways from FOMC decision

As expected, the Fed decided to hold rates at current levels. However, it altered the language in its announcement from a tightening to a neutral bias which all but lays out the red carpet for a first rate cut in September.
Inflation had previously been characterized as “elevated” but is now being characterized as “somewhat elevated.” The recent data was described as having made “some further progress”, which is an improvement over the previous language of “modest further progress” used in the last statement.1
In the assessment of the economy, the Fed characterized GDP growth as “solid”, but the FOMC acknowledged that job gains have “moderated” and noted that unemployment rate has “moved up”.1
Despite the fact that the Fed gave no firm commitment about a September rate cut, markets have reacted positively to the Fed. Stocks rose and yields fell.
We believe that it’s very likely that the Fed will in fact cut rates in September – and again in December. Keep in mind that the Fed has used Jackson Hole as an opportunity to unveil significant changes to monetary policy, so that might be when we get a stronger signal that rate cuts will begin in September.
We anticipate that if the Fed begins to cut in September, it will be able to avoid a recession, and that the US economy would likely experience a re-acceleration in growth in late 2024/early 2025.
Investment implications
We continue to favor an overweight to risky assets while noting the need to keep risks tightly controlled as very tight valuations limit the upside for risky assets.
Equities. With our belief that global economic growth is likely to improve, we favor cyclical and small cap equities given relatively attractive valuations and greater sensitivity to the economic cycle.
We also prefer developed ex-US and emerging markets equities for those same reasons. As central banks cut rates, we anticipate that valuations should also see support from lower discount rates.
Bonds. With bond yields sitting near their highest levels in decades, we believe bonds also offer attractive opportunities as rate cuts unfold.
Given the near-zero duration of bank loans, we expect them to be relatively immune to interest rate volatility compared to other fixed income asset classes and could complement a fixed income portfolio. We also anticipate strong performance from emerging markets local and hard currency bonds given our expectations for a weakening US dollar.
Real estate. We are also finding more opportunities in real estate. We believe that significant negative sentiment is already reflected in the price, and there could be meaningful upside potential as the environment improves.
For example, cuts in policy rates provide scope for reductions in real estate debt costs and capitalization rates, which we believe could lead to renewed transaction activity and progress toward price recovery.
Currencies. We anticipate the US dollar will begin to weaken this year as the Fed begins to cut rates.
Key risks to our view
Even if the Fed cuts in September, that will be 14 months in which the fed funds rate remained at its terminal level after rate hikes (in 1994-1995, the terminal level was only maintained for five months before cuts began). And so we do believe recession risks will rise every day if rates remain at these current restrictive levels.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Reference:
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1
Source: US Federal Reserve, as of July 31, 2024