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Today’s shifting market dynamics

Watch this webinar to gain valuable insights to help you navigate evolving capital market considerations.

Key takeaways

  • As expected, the Federal Reserve held interest rates steady at its initial 2024 policymaking meeting in late January.

  • It marks the fourth consecutive meeting with no change to interest rates after raising rates eleven times between 2022 and 2023.

  • Fed officials anticipate they will begin cutting rates in the months ahead, but the timing of those cuts is unclear.

Investors are preparing for a reversal of Federal Reserve (Fed) interest rate policy in the months ahead. The Fed raised the short-term federal funds target rate it controls eleven times between March 2022 and July 2023. Since that time, it has held rates steady. That was the case again at the January 2024 meeting of the policymaking Federal Open Market Committee (FOMC). While investors appear eager for the Fed to begin cutting rates, it’s not clear yet when rate cuts might be initiated. The FOMC’s last rate adjustment occurred in July 2023, when it increased the fed funds rate to a range of 5.25% to 5.50%, the highest target rate since 2001.

Chart depicts the Federal Reserve's target federal funds rate 2000-January 31, 2024.
Source: U.S. Federal Reserve, January 31, 2024.

After the FOMC’s January 2024 meeting, their statement made clear additional rate hikes were off the table, barring a dramatic change in the economy’s current direction. Based on indications the Fed made in late 2023,1 markets began to price in a series of fed fund rate cuts for 2024, with many anticipating that such cuts would begin as soon as March. After January’s FOMC meeting, the timing of a start date for rate cuts seems less certain. “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,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management.

In an official release following January’s FOMC meeting, it was stated that “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”2 Inflation, as measured by the Consumer Price Index, stood at 3.4% in December.3 In the same month, a closely watched Fed inflation measure, the core personal consumption expenditures (PCE) index, was 2.9% higher than the previous year.4

 

Market reacts to Fed policy moves

Immediately after the December FOMC meeting, when the Fed gave its first official indication that rate cuts were likely in 2024,1 stocks rallied, and Treasury bond yields fell. By mid-January, the benchmark S&P 500 stock index reached new all-time highs. The 10-year U.S. Treasury note yield dropped below 4%, its lowest level since July 2023.

“By the end of January 2024, the markets were walking back Fed rate cut expectations they priced in during the closing weeks of 2023,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “The economic data, such as real Gross Domestic Product growth (up 2.5% in 2023),4 continues to look fairly strong.” Haworth says the markets were pricing in five or more Fed rate cuts in 2024, even though the Fed, in a summary released after its December 2023 meeting indicate that only three rate cuts were likely.

While few anticipated a fed funds rate cut to occur as early as January, markets initially priced in the first rate cut for the Fed’s meeting on March 19-20, 2024. When asked, after the FOMC’s January meeting, about the possibility of the Fed cutting rates in March, Fed Chairman Jerome Powell stated, “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March as the time to do that.”5 Powell did, however, confirm earlier Fed projections that rate cuts would begin at some point in 2024.

 

Inflation’s stickiness

A primary Fed focus since 2022 was 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 dropped significantly 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 the 2% level.” Freedman says current rates may not be sustainable at their current high levels before they start causing damage to the pace of economic growth.

Haworth agrees, noting that the Fed may eventually feel increasing pressure to begin cutting rates. “Now that inflation has dropped, the current fed funds rate is higher on a real (after-inflation) basis than it was back when inflation was 9%.” Haworth adds that “at some point, the Fed may feel it’s being tougher on the economy than it really needs to be.”

Haworth also believes the Fed may need to consider scaling back its “quantitative tightening” strategy. This approach has seen the Fed reduce its bond holdings since mid-2022. “The Fed may determine it needs to help maintain some liquidity in fixed income markets by slowing or stopping its balance sheet reduction for a period of time,” says Haworth. “This might be important in an environment where the U.S. Treasury needs to increase its debt issuance to keep pace with an expanding debt load.” However, in January, the FOMC choose to continue trimming the Fed’s balance sheet and gave no indication a change was likely in coming meetings.

Despite significant Fed monetary tightening, the U.S. economy proved resilient. In his January 2024 comments, Powell stated, “Recent indicators suggest that the growth of economic activity has been expanding at a solid pace.” Powell added, “As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals are moving into better balance.”6

 

Role of the Fed

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.

“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 the 2% level,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management.

Will the investment environment change?

With the Fed indicating it has reached the peak in its current interest rate-hiking cycle and rate cuts are likely ahead, what does it mean for investors? Today’s market appears to offer opportunities for investors to return to more neutral portfolio positioning. Here are potential moves that may be appropriate for a diversified portfolio given the current environment:

  • Fixed income market. Although bond yields have slipped from their peak, interest rates remain elevated compared to the environment prior to 2022. That makes fixed income securities more attractive. While higher yields can be earned in short-term debt instruments, it’s important to also consider longer-maturity U.S. Treasuries as well to help support portfolio diversification. “You don’t want to invest just with a 30- to 90-day outlook,” says Haworth. “You want to look at what’s going to work more effectively to help you meet your long-term goals.” Tax-aware investors may want to consider a modest allocation to high yield municipal bonds. Within certain non-taxable portfolios, explore a meaningful investment in non-government agency residential mortgage-backed securities. Trust portfolios may consider reinsurance to capture attractive income with low correlation to other portfolio components.
  • Equity markets. Equities retreated between August and October but rallied significantly since that time. Haworth says investors still must be prepared for choppiness in the markets. “Some measures of the market look slightly riskier today than previously. Investors who have assets to deploy in the stock market may wish to consider dollar-cost averaging over a period of time (consistently investing over at least a six-month period).” This systematic investment approach has the potential to mitigate risks during volatile market periods, while still allowing investors to put money to work in equities to meet long-term goals.

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 changing interest rate environment.

Frequently asked questions

Related articles

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As interest rates change, learn what the ripple effects across capital markets may mean for investors.

How changing interest rates impact the bond market

With the Federal Reserve maintaining higher interest rates for longer to get inflation under control, what opportunities does this create for bond investors?

Disclosures

Start of disclosure content
  1. Edmondson, Catie, “McCarthy is Ousted as Speaker, Leaving the House in Chaos,” The New York Times, Oct. 3, 2023.

  2. Board of Governors of the Federal Reserve System, “Open Market Operations.”

  3. Source: U.S. Bureau of Labor Statistics.

  4. Source: U.S. Bureau of Economic Analysis.

  5. Pound, Jesse, “Fed Chief Jerome Powell says a March rate cut is not likely,” CNBC.com, Jan. 31, 2024.

  6. Board of Governors of the Federal Reserve System, “Transcript of Chair Powell’s Press Conference Opening Statement, Jan. 31, 2024.”

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