Key takeaways
As it has since late 2023, the Federal Reserve continued to hold the line on interest rates at its March 2024 meeting of the Federal Open Market Committee.
It marked the fifth consecutive meeting with no change to interest rates after the Fed raised rates eleven times between 2022 and 2023.
Fed officials have indicated as many as three rate cuts may be coming later this year.
As investors await the April 30-May 1 meeting of the Federal Reserve’s policymaking Federal Open Market Committee (FOMC), they’ve adjusted to an environment marked by changing expectations. Prospects for interest rate cuts appear to be on hold for now. The Fed has indicated that the fed funds rate it controls may be at a peak for the current cycle (in the 5.25% to 5.50% range, its highest level since 2001). The Fed opened the door to rate cuts in 2024 after recent FOMC meetings. However, a series of economic developments have likely contributed to the Fed’s wariness about cutting rates prematurely.
After the FOMC’s March 2024 meeting, a report released by its members continues to project three cuts to the fed funds rate this year.1 The flow of economic data since that time has led to growing skepticism among market participants that the Fed can follow through on this projection. “We’ve seen a meaningful inflation slowdown,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. “Yet inflation remains a bit sticky, and the Fed realizes that once they start with rate cuts, it is hard to stop doing so in future meetings.” In a statement released after its March meeting, Fed Chair Jerome Powell stated, “The Committee does not expect it will be appropriate to reduce the (fed funds) target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”2
Inflation, as measured by the Consumer Price Index (CPI), stood at 3.5% in March, raising some concerns as it represents an uptick from previous months. At the same time, the so-called “core” inflation rate (excluding the volatile food and energy sectors) rose 3.8% over the same one-year period.3 Another inflation measure, one watched closely by the Fed, is the core personal consumption expenditures (PCE) index. It stood 2.8% higher at the end of February compared to the previous year. The core PCE news was encouraging to the extent that it represents its lowest reading in almost three years, but further reduction to the Fed’s 2% target remains elusive.4
In the meantime, there are other signs that the economy is expanding more steadily than many predicted, and perhaps beyond the Fed’s expectations. The U.S. economy added 303,000 jobs in March, and there remain approximately 1.4 available workers from every open job in the United States.
Investors appear to be recalibrating expectations in light of recent economic developments and Fed signals. After the Fed first indicated in late 2023 that fed fund rate cuts were on the table, markets initially priced in the first rate cut for the Fed’s meeting in March 2024. However, as various Fed officials commented in recent months that rate cuts weren’t imminent, markets backtracked in April’s first half. In that period, the S&P 500 dropped 2.5% while the benchmark 10-year U.S. Treasury yield jumped from 4.20% to 4.50%. Bonds, as represented by the Bloomberg Aggregate Bond Index and as measured on a total return basis, declined 1.75% in April’s first two weeks (bond prices fall when yields rise).5
“We’ve seen a meaningful inflation slowdown,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. “Yet inflation remains a bit sticky, and the Fed realizes that once they start with rate cuts, it is hard to stop doing so in future meetings.”
A primary Fed focus since 2022 has been to temper the rapid rise in the cost of living. Headline inflation, as measured by the Consumer Price Index (CPI), peaked at 9.1% for the 12-month period ending in June 2022, but then began to steadily decline. However, after dropping to as low as 3% in June 2023, inflation remained above that level since.3
“The Fed has had opportunities to change its 2% annual inflation target, and it hasn’t done so,” says Freedman. “Despite its progress since early 2022, current inflation is still above the Fed’s target rate. But we think the Fed will have to start cutting rates before inflation drops to 2%.” In fact, the FOMC’s projections indicate its expectations are that inflation will remain above 2% in 2024 and 2025, even as the FOMC likely implements rate cuts over those two years.1
Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management, anticipates that the Fed may scale back its “quantitative tightening” strategy. This approach has seen the Fed reduce its bond holdings since mid-2022 at a rate of $95 billion per month. “At some point, the Fed may consider slowing the pace of their tapering,” says Haworth. “Though in terms of the market’s response, such a move probably has less impact than a decision to start lowering the fed funds target rate.” The Fed’s balance sheet of asset holdings grew to just under $9 trillion in early 2022. It’s now dropped to less than $7.5 trillion.6 While the Fed intends to continue reducing its balance sheet for now, Fed Chair Jerome Powell said in March that “it will be appropriate to slow the pace of runoff (balance sheet reduction) fairly soon, consistent with the plans we previously issued.”2
Despite significant Fed monetary tightening, the U.S. economy remains resilient, and it appears that the Fed expects growth to continue. That includes an upgrade to anticipated 2024 economic growth as reflected in Gross Domestic Product (GDP). In December, Fed members projected 2024 GDP growth of 1.4%, but have now raised their projection to 2.1%. In addition, it sent encouraging signals on the labor front, anticipating fairly stable conditions. The FOMC projects employment at 4.0% for the year, not far from the most recent reading of 3.9%.1 While wage growth has been one driver of inflation in recent times, Powell stated in March that “wage increases have been quite strong, but they are gradually coming down to levels that are more sustainable over time,”2 indicating the Fed sees a diminishing inflation threat from current wage growth trends.
Congress’ mandate for the Fed is to maintain price stability (manage inflation); promote maximum sustainable employment (low unemployment); and provide for moderate, long-term interest rates. Fed monetary policy influences the cost of many forms of consumer debt such as mortgages, credit cards and automobile loans. While Chair Powell receives much of the attention, the FOMC establishes Fed monetary policy, setting the fed funds target rate and the buying and selling of securities.
What do recent economic and market developments mean for investors? Today’s market appears to offer opportunities to return to more neutral portfolio positioning. Here are potential moves that may be appropriate for a diversified portfolio given the current environment:
Be sure to consult with your financial professional to review the positioning of your portfolio to determine if changes might be appropriate given your goals, time horizon and feelings toward risk given today’s evolving interest rate environment.
Monetary policy is controlled by a nation’s central bank, which in the United States, is the Federal Reserve (Fed). The Fed’s management of monetary policy can have a significant impact on the shape of the nation’s economy. Congress’ mandate for the Fed is to maintain price stability (manage inflation); promote maximum sustainable employment (low unemployment); and provide for moderate, long-term interest rates. Fed monetary policy influences the cost of many forms of consumer debt such as mortgages, credit cards and automobile loans.
The Fed is the nation’s central bank, and perhaps the most influential financial institution in the world. It is charged with helping the U.S. maintain stable prices (inflation), promote maximum sustainable employment and provide for moderate, long-term interest rates. These functions have a significant impact on the broader economy. The central governing board of the Federal Reserve reports to Congress, with the chair of the Federal Reserve appointed by the President. There are also 12 regional federal reserve banks that are set up like private corporations.
The Federal Reserve’s Federal Open Market Committee (FOMC) sets a target interest rate policy for the federal funds rate. This is the rate at which commercial banks borrow and lend excess reserves to other banks on an overnight basis. The fed funds rate is raised or lowered usually to help impact underlying economic conditions. For example, in 2022, as inflation surged, the FOMC began raising interest rates in an effort to make borrowing more expensive and slow economic activity. That strategy was designed to ease pricing pressures and reduce the inflation rate. In periods when the economy is slow or in a recession, the Fed tends to lower rates to try to stimulate economic activity and help the economy expand again.
As interest rates change, learn what the ripple effects across capital markets may mean for investors.
With the Federal Reserve maintaining higher interest rates for longer to get inflation under control, what opportunities does this create for bond investors?
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