{"id":20514,"date":"2024-12-20T09:55:01","date_gmt":"2024-12-20T14:55:01","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-us\/?p=20514"},"modified":"2024-12-20T09:55:02","modified_gmt":"2024-12-20T14:55:02","slug":"the-fed-approaches-a-new-phase-of-interest-rate-policy","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-us\/insights\/the-fed-approaches-a-new-phase-of-interest-rate-policy","title":{"rendered":"The Fed approaches a new phase of interest rate policy"},"content":{"rendered":"\n

By Atul Bhatia, CFA<\/strong><\/p>\n\n\n\n

\n The Fed\u2019s decision to cut interest rates by 25 basis points (bps) on Dec.\n 18 was hardly a surprise. The move was predicted by almost 90 percent of\n economists surveyed by Bloomberg and was fully consistent with interest\n rate futures pricing ahead of the decision.\n <\/p>\n

\n Slightly more noteworthy, in our view, were the changes to the central\n bank\u2019s Summary of Economic Projections (SEP)\u2014known colloquially as the\n \u201cdot plot.\u201d These showed policymakers shifting their projections higher\n for year-end 2025 GDP growth, inflation, and policy rates. Notably,\n policymakers now see only two 25 bps cuts in 2025, putting the median\n projection for the year-end federal funds rate 50 bps higher than it was\n at the September policy meeting.\n <\/p>\n

\n But what really got markets to take notice was the hawkish tone to Fed\n Chair Jerome Powell\u2019s remarks, where he said that it would take further\n progress on inflation to justify additional rate cuts. Following his\n comments, U.S. Treasury bond yields rose between eight and 15 bps,\n depending on maturity, while the S&P 500 fell nearly three\n percent.\n <\/p>\n

\n Despite this initial selling pressure following the Fed announcements, we\n believe a rate-cut pause is both warranted and salutary, and investors\n should focus on the economic strength driving the policy shifts.\n <\/p>\n \n

Data dependent, but for real this time<\/h2>\n

\n Since before this rate-cut cycle began in September, Powell has claimed\n the central bank\u2019s moves were \u201cdata dependent.\u201d Likely true, but only\n technically so from our vantage point. Since July, we think rate cuts were\n largely pre-determined. An outlier reading could have kept rates\n unchanged, but for all practical purposes, data dependency was purely\n theoretical.\n <\/p>\n

\n Based on the Fed\u2019s most recent comments, however, our sense is that the\n central bank is now shifting into a more natural reading of \u201cdata\n dependency,\u201d where it comes at the decision with a neutral bias, and it\n will only move if the data justifies it.\n <\/p>\n \n

Fed projections warrant hawkish shift<\/h3>\n
\n \n \n \n Metric<\/th>\n December meeting<\/th>\n September meeting<\/th>\n Change<\/th>\n <\/tr>\n <\/thead>\n \n \n Change in real GDP<\/td>\n 2.1%<\/td>\n 2.0%<\/td>\n +0.1%<\/td>\n <\/tr>\n \n Unemployment rate<\/td>\n 4.3%<\/td>\n 4.4%<\/td>\n -0.1%<\/td>\n <\/tr>\n \n PCE inflation<\/td>\n 2.5%<\/td>\n 2.1%<\/td>\n +0.4%<\/td>\n <\/tr>\n \n Core PCE inflation<\/td>\n 2.5%<\/td>\n 2.2%<\/td>\n +0.3%<\/td>\n <\/tr>\n \n Federal funds rate<\/td>\n 3.9%<\/td>\n 3.4%<\/td>\n +0.5%<\/td>\n <\/tr>\n <\/tbody>\n <\/table>\n

\n Source – RBC Wealth Management, U.S. Federal Reserve\n <\/p>\n <\/div>\n \n

And as we look at the numbers, we think a pause is clearly warranted.<\/p>\n

\n The Fed\u2019s job is to maximize employment consistent with stable prices. How\n is it doing? Well, it\u2019s hard to argue there\u2019s an employment problem. The\n benchmark unemployment rate is nearly one percent below its long-term\n median, and the broadest measure of labor weakness\u2014which captures\n discouraged and underemployed workers\u2014looks even stronger; it\u2019s 1.6\n percent below the long-term median. These measures have drifted slightly\n higher, but it\u2019s undeniable that employment is stronger now than it was\n during prior economic expansions, let alone recessions.\n <\/p>\n \n

Broadest U.S. labor measure shows little weakness<\/h3>\n
\n
\n \"U-6\n

\n The line chart shows the U.S. U-6 unemployment rate, the broadest\n measure of labor availability, with its median of 9.4% for the past 30\n years. The U-6 rate was around 6.8% in December 2019, before the\n COVID-19 pandemic, and then spiked to nearly 23% in April 2020 before\n falling rapidly back to 6.5% in December 2022. The rate has risen\n gradually since then, and is now roughly 7.8%.\n <\/p>\n

    \n
  • \n
    <\/div>\n U-6 unemployment rate\n <\/li>\n
  • \n
    <\/div>\n Median\n <\/li>\n <\/ul>\n

    \n The U-6 unemployment rate includes the total unemployed, plus all\n persons marginally attached to the labor force, plus total employed\n part time for economic reasons.\n <\/p>\n

    \n Source – RBC Wealth Management, Bloomberg; monthly data through\n 11\/30\/24\n <\/p>\n <\/div>\n <\/div>\n

    \n Inflation\u2014and not job creation\u2014is arguably where the Fed should be\n focused, a stance that Powell\u2019s press conference seemed to finally\n acknowledge. The core components of the Consumer Price Index (CPI), which\n excludes food and energy, are up over three percent year-over-year and\n prices on the broad basket of goods have been rising at an accelerating\n monthly pace. The Fed\u2019s two percent inflation target is technically based\n on a different measure of consumer prices, the Personal Consumption\n Expenditures Price Index (PCE), that was up 2.3 percent year-over-year in\n October, the last available reading.\n <\/p>\n

    \n Normally, it would be reasonable to say that being within 0.3 percent of\n the inflation target is close enough. But this is not a normal inflation\n environment. We\u2019re coming off a bout of near-double-digit inflation and it\n has left its mark on the U.S. economy. Even as annual inflation levels\n have moderated, market indicators of longer-term inflation expectations\n have remained above pre-pandemic levels. Expectations on price moves tend\n to be self-fulfilling; typically, businesses that expect higher supply\n costs are quick to raise prices and workers who think costs are going up\n are more aggressive in looking for wage gains.\n <\/p>\n

    \n Against that backdrop, Powell\u2019s emphasis on inflation progress as a\n prerequisite for further cuts is reasonable, in our view. A contrary\n stance could risk losing control of the inflation narrative.\n <\/p>\n \n

    Message of the markets<\/h2>\n

    \n Although the S&P 500 sold off following the hawkish tone to\n Powell\u2019s press conference, we think it\u2019s a mistake to conclude that equity\n prices depend on lower interest rates.\n <\/p>\n

    \n For support, we need to look no further than the market\u2019s response since\n the Fed initiated its rate-cut cycle in September. Back then, investors\n were pricing in 2.5 percent of policy easing; today, that number is closer\n to 1.4 percent. Despite that shift toward higher future interest rates,\n and even with yesterday\u2019s selling, the S&P 500 gained five\n percent since the Fed\u2019s meeting in September. With monetary policy being\n driven by economic strength, we see nothing inconsistent with higher rates\n and higher stock prices.\n <\/p>\n

    \n We think the bond market is telling a similar story. Going into the Fed\u2019s\n September meeting, 10-year government bond yields were roughly 1.25\n percent below three-month rates. As of Dec. 18, those rates are now\n essentially the same.\n <\/p>\n

    \n This type of relative move\u2014referred to as curve steepening\u2014can be a\n worrying sign when it\u2019s driven by the Fed aggressively cutting short-term\n interest rates to stimulate a slowing economy. That\u2019s not the case today,\n when the bulk of the steepening has come from rising long-term yields.\n That type of move is more consistent with a market pricing in solid\n economic growth and inflation risks than one that is concerned with an\n incipient recession.\n <\/p>\n \n

    Risks remain<\/h2>\n

    \n Putting it all together, we think a pause in rate cuts is clearly\n warranted. After that, policy should\u2014and likely will\u2014boil down to how\n prices and labor markets are performing. While current indicators are\n generally positive and could be consistent with little or no additional\n policy easing, future developments could warrant more aggressive rate cuts\n than the Fed currently projects.\n <\/p>\n

    \n The most obvious path we see for further easing is slowing inflation and\n rising unemployment, possibly from global economic softening reaching the\n U.S. Politics is also a potential factor. There is a growing probability\n of a U.S. government shutdown, for instance. In addition, the incoming\n Trump administration has indicated a wide-ranging set of measures that\n could create unanticipated, negative short-term economic consequences.\n <\/p>\n

    \n All in all, we think investors need to focus not only on what the Fed is\n doing, but why. And a shift toward slower interest rate cuts based on\n robust domestic economic performance is nothing to be feared.\n <\/p>\n","protected":false},"excerpt":{"rendered":"

    Markets head lower following a hawkish rate cut by the U.S. Federal Reserve. We discuss the reasons behind the Fed\u2019s shift and if investors really need to fear higher rates caused by stronger growth.<\/p>\n","protected":false},"author":15,"featured_media":20513,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"rbcwm_post_date":"2024-12-19T16:50:57","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[71],"tags":[480,715],"rbcwm_content_owner":[609],"rbcwm_need":[],"rbcwm_segment":[],"rbcwm_solution":[],"rbcwm_topic":[468],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-20514","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","tag-gdp-growth","tag-interest-rate-policy","rbcwm_content_owner-pag","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"Markets head lower following a hawkish rate cut by the U.S. Federal Reserve. We discuss the reasons behind the Fed\u2019s shift and if investors really need to fear higher rates caused by stronger growth.","rbcwm_post_author":"","rbcwm_custom_breadcrumb_text":"","rbcwm_custom_breadcrumb_link_url":"","rbcwm_disclaimers":{"add_disclosures":["Yes"],"perspective_disclaimer":"","expandable":"","omit_from_pages":[],"disclaimer_footnote":""},"rbcwm_insight_cta_id":[8484],"rbcwm_pagination":{"next_link":"","next_link_text":"Next article","previous_link":"","previous_link_text":"Previous article"},"rbcwm_video_duration":"","article_time":"","rbcwm_enable_toc":false,"rbcwm_toc_selector":"h2"},"yoast_head":"\nThe Fed approaches a new phase of interest rate policy<\/title>\n<meta name=\"description\" content=\"Markets head lower following a hawkish rate cut by the U.S. Federal Reserve. 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