Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The US equity market, represented by the S&P 500 index, slipped 3% for the week ending September 22.
  • The Fed caused consternation in capital markets this week with its “higher for longer” messaging on its interest rate policy.

The Federal Reserve’s Open Market Committee (FOMC), the part of the Fed that makes interest rate decisions, met on Wednesday and decided to hit the “pause” button, keeping its target interest rate range where it currently stands (5.25% to 5.5%). This was widely expected: the CME Group’s FedWatch tool, which analyzes 30-day Fed Funds futures pricing, had an implied probability of 99% that the Fed would stand pat.

Rather than cheering this decision, the bond market sold off. The ten-year US Treasury note yield edged upward toward 4.5%, as high as it has been in 16 years.

The move higher in rates can be attributed to the Fed’s communication surrounding its rate hike pause on Wednesday. The Fed now thinks that economic growth will continue and that the softest of soft landings is possible for the economy.

Inflation may be irritatingly above the Fed’s 2% target, however, which means that interest rates may stay “higher for longer”. There is now a plurality of Fed officials (10 out of 19) who believe that rates should be above 5% by the end of 2024, and almost no one who believes that rates will be below 4.5%.[i]

The “higher for longer” outlook, along with being a good name for a cannabis dispensary, has resulted in a rapid shift in investor expectations for Fed rate cuts in 2024. This can be witnessed in the futures data on the CME’s website. A month ago, investors had assigned a 27% chance for a rate cut at the March 20, 2024 FOMC meeting. The probability now is 11%. A month ago, investors placed a 14% chance for a rate cut at the January 31, 2024 meeting. That probability has gone to zero.

The pushing out of expectations for rate cuts has meant that longer-term interest rates have risen, which, if persistent, could ultimately result in the un-inversion of the yield curve. The Fed doesn’t have to raise rates to tighten policy. It can just do nothing.

While the Fed generated market volatility this week, monetary policy isn’t the only government policy affecting markets. A research piece from Citrini Research this week made a very similar point to the one made by my colleague, Steve Nilles, in his note last weekend: there is also fiscal policy, US government spending, to consider.

For quite some time, both political parties have embraced expansive spending, albeit with different policy goals. Citrini’s thesis is that trillions of dollars will be transmitted to the economy in the coming years, from the government to the private sector. Investors routinely underestimate the outsized impact of fiscal policy on the economy, while regularly overweighting the Fed’s monetary policy impact.

The reason for the outsize impact of fiscal policy is that every dollar of US government deficit spending eventually ends up as corporate profits. There are risks to running a budget deficit, and other drivers of corporate profits matter, as well. Nevertheless, US government deficits are an important source of corporate profits, and whether deficits are created by tax cuts or through higher spending, those profits impact securities in investor portfolios.

[i] Matthew Klein, “The Fed’s Bullishness Is Pushing Up Rates”, September 21, 2023

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