September 2018 Fed Raises Rates Again

The Federal Open Market Committee (FOMC) announced today that it is increasing the range on the federal funds rate to (2.00% - 2.25%) from (1.75% - 2.00%). This is the third hike in 2018 and the eighth since they began normalizing rates in 2015. Details from the meeting follow.

Language Changes and Themes

  • “Labor market has continued to strengthen, and economic activity has been rising at a strong rate.”
  • “Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low.”
  • “Household spending and business fixed investment have grown strongly.”
  • “Overall inflation and inflation for items other than food and energy remain near 2%.”
  • The Fed removes “accommodative” from their monetary policy description
  • The Fed signaled a rate hike in December - the fourth for 2018 - and three more rate hikes for 2019. This would put the projected rate at 3.125%.

Recent Market Action

  • Rates across the yield curve continued to rise in anticipation of future rate hikes, further unwinding of the Fed’s balance sheet, increased Treasury issuance, and bouts of foreign selling
  • Quarter-to-date, front-end rates have risen the most, resulting in a flatter yield curve relationship between the 2-year and 10-year part of the curve
  • The longer (20+ year) portion of the yield curve continues to underperform the short and intermediate maturities year-to-date on a total return basis, but returns have been negative across the Treasury curve 3 years and longer
  • Despite increased volatility in the equity markets, major indices are near all-time highs

Conclusion

The market fully expected this rate hike to occur. The Treasury market had minimal reaction post-hike while stocks rallied further from initial gains on the day. In anticipation of further Fed tightening, LIM continues to position its clients’ portfolios with a duration profile shorter than their respective benchmarks. Any future decision on rate hikes will continue to be data dependent. The Fed’s base case is to implement steady rate increases over the next 15 months, culminating in a neutral Fed Funds rate ranging from 3.00% to 3.25%.

The composition of the Federal Reserve Board of Governors has begun to come into focus with Richard Clarida being confirmed this month. The Fed now has four board members with three positions which still need to be filled by the administration. The latest nominee is Nellie Liang. Liang is a former Fed economist who was an active member of the Fed staff assisting in oversight of the financial system after the 2008 crisis. Our best guess for successful appointees are Nellie Liang and Michelle Bowman. Marvin Goodfriend’s nomination remains in jeopardy.

The Fed continues to unwind its balance sheet of Treasuries and mortgages, which should top out at $50 billion a month later this year. In addition, any fiscal stimulus policy initiatives would require additional Treasury supply, which should also put upward pressure on rates. If growth is stronger than anticipated, expect the Fed to move more aggressively to increase rates. Conversely, if there is a shock to the system which causes a flight to quality, expect the Fed to delay future rate hikes until the markets normalize. On the inflation front, we are trying to ascertain the Fed’s level of comfort in allowing inflation to run higher than its long-term 2% target. Technical forces continue to be very influential on the rate markets.

Disclosure

The opinions contained herein are those of Longfellow Investment Management Co., LLC (LIM) at time of publication and may vary as market conditions change. They are based on information obtained by LIM from sources deemed to be accurate and reliable. However, accuracy is not guaranteed. It is in the sole discretion of the reader whether to rely upon the opinions contained herein. The information provided does not constitute investment advice, is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy and should not be relied upon as such. It does not take into account an individual investor’s particular investment objectives, strategies, tax status or investment horizon. There is no guarantee that any forecasts contained herein will come to pass.  Past performance is not an indication of future results. Investment involves the possible loss of principal.