September 20, 2022
The home of the Federal Reserve Bank is on Constitution Avenue in Washington, DC. That’s just a few blocks away from our headquarters so we speak from experience when we say: As the Fed considers a historic third 75 basis point increase, it’s quiet on Constitution Avenue. FOMC participants have clearly stated they will raise rates higher and hold them high for as long as it takes. Not much discussion needed at this meeting. Perhaps: Should we go up 100 basis points? But it will be the review of the surprisingly strong August CPI reading and turn in your economic estimates for the DOT plot. We expect plenty of tough talk from the Chairman at his press conference on Wednesday, including warnings of recession, and not a care about market volatility.
Why? Let’s review the four scenarios we predict could happen in the near term:
1. The Fed defeats inflation
2. A recession happens
3. Volatility increases
4. inflation remains hot and the economy continues growing
The first three scenarios, the Fed might ease rates and long rates might comes down. But given the latest economic readings, the fourth scenario seems to be winning. But we ask ourselves, is that sustainable? Since the release of the August CPI report, the CME Fed Watch Tool (Below) now anticipates the Fed raising rates, September (75 bps), November (75 bps) and December (50 bps) to end the year at 4.25-4.50%. The futures also show the Fed will keep rates around that 4-4.5% level for most of 2023. The Fed can’t do anything to fix the supply chain, but they can and will do something about demand for those supplies.
As we look closely at those scenarios, we see two themes for fixed income. Credit spreads could continue to widen. Credit spreads are above long-term averages, but not quite at recession or crisis levels and there is still room to widen. Long term rates, while volatile in the immediate term, could start to come down as soon as the Fed signals they are done raising rates. We are closing in on the 4th quarter of 2022. 2023 will bring in a new investment thesis that will include a new outlook on rates. We think that outlook could be for lower rates as the Fed either won or went too far.
-Peter Baden, CFA
Chief Investment Officer
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CME Fed Watch Tool
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William (Kip) Weese
SVP, Intermediary Sales
Northeast & South West
VP, Intermediary Sales
VP, Intermediary Sales
North Central & North West
Indexes used for AAA Municipal Yields
2 Year: BVAL Municipal AAA Yield Curve (Callable) 2 Year (Symbol: CAAA02YR BVLI)
5 Year: BVAL Municipal AAA Yield Curve (Callable) 5 Year (Symbol: CAAA04YR BVLI)
10 Year: BVAL Municipal AAA Yield Curve (Callable) 10 Year (Symbol: CAAA10YR BVLI)
30 Year: BVAL Municipal AAA Yield Curve (Callable) 30 Year (Symbol: CAAA30YR BVLI)
Indexes used for US Treasury Yields
2 Year: US Generic Govt 2 Year Yield (Symbol: USGG2YR)
5 Year: US Generic Govt 5 Year Yield (Symbol: USGG5YR)
10 Year: US Generic Govt 10 Year Yield (Symbol: USGG10YR)
30 Year: US Generic Govt 30 Year Yield (Symbol: USGG30YR)
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