Tom Wald, CFA®, Chief Investment Officer, Transamerica Asset Management, Inc.
In this article we review:
The Federal Reserve’s decision to leave rates unchanged at its recent November meeting
Why we believe the Fed has now likely concluded its tightening cycle with no further rate hikes
Recent volatility in longer-term rates and how that might play into Fed policy decisions
The future path of longer-term interest rates and slope of the yield curve
Potential slowing of economic growth in the months ahead
Recent inflation data continuing to display an encouraging downward trend
Current opportunities in the stock and bond markets
As expected, the Federal Reserve left the federal funds rate unchanged at its meeting concluding on November 1. Markets reacted favorably immediately thereafter as longer-term interest rates fell and stocks rallied. Given this backdrop and recent volatility in both the stock and bond markets, we believe the following points are important for investors.
Lack of hawkishness interpreted as dovish. Markets seemed to take a dovish interpretation of the little changed Fed statement and Chair Jay Powell’s post-meeting press conference reiterating most of the same messaging previously conveyed at the September meeting. As a result, Chair Powell’s commentary regarding a “higher for longer” policy approach, with further rate hikes still under consideration, did not seem to be enough to convince markets an upcoming December rate hike is a high probability.
Impact of rising longer-term rates looks to also be at play. A very small wording addition in the Fed’s statement of “financial” to the sentence, “Tighter financial and credit conditions for businesses and households are likely to weigh on economic activity,” (in reference to the recent surge in long-term interest rates) also appeared to be interpreted as incrementally dovish. This would also be consistent with the premise that with Treasury yields having risen considerably at the long end of the yield curve, the markets have done much of the Fed’s work in recent weeks, making further rate hikes less necessary.
We believe that at this time the Federal Reserve has concluded its tightening cycle and will not raise rates further from this point on. That said, we do not expect to see rate cuts until at least about mid-year 2024 and believe the yield curve will continue dis-inverting and resume an upward slope during the year ahead, likely pressuring rates at the longer end of the yield curve higher.
Declining job growth also supports end to Fed rate hikes. On November 3, the Bureau of Labor Statistics released the October nonfarm payroll report showing 150,000 new jobs added to the economy. This was below expectations and, in addition, contained downward job revisions of 101,000 for the months of August and September, thereby further inferring slowing in the labor market. Unemployment ticked up by 0.1% to 3.9%, representing its highest level since January 2022. We view this report as indicative of employment as a lagging economic indicator, perhaps now reflecting a slowing trend and supporting the end of the Fed’s rate hike tightening cycle.
Further economic slowing could also be on the horizon. It is our judgment that more softening economic data could be coming to the forefront following the recently released and unusually strong 3Q gross domestic product report of 4.9% annualized growth (Bureau of Economic Analysis Advanced Estimate, October 26), which looks to be a high-water mark for this cycle. Early indications are that economic growth — potentially due to the increasing impacts of previous rate hikes, higher long-term rates spilling over into the credit and mortgage markets, depleting levels of consumer spending, mounting credit card debt, and the resumption of student loan payment requirements — could begin to slow considerably or potentially turn negative in 4Q and/or the early months of 2024.
Inflation continues to move in the right direction. Inflation continued to follow a downward trend since peaking two summers ago. According to the Fed’s preferred metric, personal consumption expenditures (PCE), core inflation came in for the month of September at a year-over-year headline rate of 3.7% and 3.4% for its headline reading. This represented the lowest pace on core PCE in two years, and we continue to believe core rates of inflation are heading toward 3% by the early months of 2024.
Volatility of longer-term interest rates is likely to continue. Investors endured a continuous and painful rise in long-term interest rates during the late summer and autumn months as seen in the 10-year U.S. Treasury rate, which increased from 3.97% at the end of July to as high as 4.98% on October 19, before dropping back to 4.57% as of November 3. While there were a variety of factors contributing to this rate rise, including strong economic data and additional bond issuance, in our view it is the ongoing dis-inversion of the yield curve that has driven longer-term rates higher. While we could see a continuation of the recent reversion in the 10-year Treasury yields between now and year-end as weaker economic data comes to the forefront, we believe longer-term yields could ultimately move higher as the yield curve steepens in 2024.
Given the current climate, we believe there are opportunities for investors through the end of this year and into 2024. In particular, we favor growth stocks as this asset class should benefit from a scarcity of growth factors evident in economic slowdowns as well as tailwind catalysts of declining inflation and the end of the Fed’s tightening cycle. We also see intermediate-term investment-grade and high-yield bonds as opportunistic given yields are now at or close to multi-year highs amid what we believe will ultimately prove to be a relatively benign credit environment.
Investments are subject to market risk, including the loss of principal. Asset classes or investment strategies described may not be suitable for all investors.
Past performance does not guarantee future results. Indexes are unmanaged and an investor cannot invest directly in an index.
Equities are subject to market risk meaning that stock prices in general may decline over short or extended periods of time.
Fixed income investing is subject to credit rate risk, interest rate risk, and inflation risk. Credit risk is the risk that the issuer of a bond won’t meet their payments. Inflation risk is the risk that inflation could outpace a bond’s interest income. Interest rate risk is the risk that fluctuations in interest rates will affect the price of a bond. Investing in floating rate loans may be subject to greater volatility and increased risks.
Growth stocks typically are particularly sensitive to market movements and may involve larger price swings because their market prices tend to reflect future expectations. Growth stocks as a group may be out of favor and underperform the overall equity market for a long period of time, for example, while the market favors “value” stocks. Value investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that an undervalued stock is actually appropriately priced.
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The information included in this document should not be construed as investment advice or a recommendation for the purchase or sale of any security. This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information does not take into account any investor’s investment objectives, particular needs, or financial situation. The value of any investment may fluctuate. This information has been developed by Transamerica Asset Management, Inc. and may incorporate third-party data, text, images, and other content to be deemed reliable.
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