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    CONTINUE Go Back
    1. Are markets more in line with Fed rate expectations?

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    Are markets more in line with Fed rate expectations?

    09/22/2022

    Jordan Jackson

    The short-term outlook for equities remains challenging while high-quality intermediate to long duration core bonds may be the most attractive sectors within fixed income.

    Jordan Jackson

    Global Market Strategist

    Listen to On the Minds of Investors

    09/22/2022

    Show Transcript Hide Transcript

    Jordan Jackson:              

    Hi, my name is Jordan Jackson, global market strategist at JP Morgan Asset Management. Welcome to On The Minds Of Investors. Today's post asked the question, are markets more in line with fed rate hike expectations? The Federal Open Market Committee, or FOMC, voted unanimously to raise the federal funds target range by 75 basis points to three to three and a quarter percent. The tone of the committee remains talkish, given policy makers are highly attentive to taming inflation that runs well above its 2% target.

    Strong job growth and persistent excess demand for labor suggests a soft landing is still possible. However, aggressive fed tightening keeps the probability of a recession sometime next year elevated.

    The committee delivered forward guidance through its summary of economic projections or SEP and provided a much more hawkish median dot plot. Relative to their June forecast, the FMC sees the federal funds rate ending 2022 at 4.4% and hitting a 4.6% terminal rate in 2023 with rates remaining restrictive until at least 2025. Real GDP growth projections were revised lower from 1.7% year over year in the fourth quarter of 2022 to just 0.2% and cut to 1.2% by the fourth quarter of 2023, followed by a more sustainable 1.5% to 2% rate through 2025.

    Expectations for year over year PCE deflator inflation for the fourth quarter of this year were revised higher with headline up to 5.4% from 5.2% and core up to 4.5% from 4.3%. Thereafter, inflation is still expected to cool steadily through 2025.

    The fourth quarter of this year unemployment rate forecast was nudged up to 3.8% compared to 3.7% in June. 2023 and 2024 forecast, so a more significant boost to 4.4% in each year from 3.9% and 4.1% respectively.

    In our view, the key message is from the updated SEP in dot plot are first, sticky inflationary pressures and owners equivalent rent, or OER, rental CPI and wage growth will keep core inflation stubbornly elevated into next year, while decline in energy and us gasoline prices should lead to a larger decline in headline consumer prices. The slide scene in both real GDP and productivity in the first half of the year do not reflect an economy in the recession. That said, the committee recognizes that businesses and consumers will come under pressure as the economy enters a period of higher rates.

    Third, the persisted excess demand for labor is expected to keep the rise in the unemployment rate modest, but higher unemployment is a necessary evil to kill inflation.

    Lastly, the committee will lift rates to 4% to 5% next year, and doesn't expect to begin lowering rates until 2024. The statement language was nearly identical to July and notably reiterated that ongoing increases in the target range will be appropriate keeping the door open for another 125 basis points and increases by the end of the year.

    At the press conference, Chairman Powell repeated his Jackson hole messaging, noting that restoring price stability will keep rates restrictive for some time, but at some point a slower pace of rate hikes will become appropriate. For now, the FMC remains a laser focused on inflation and keeping inflation expectations in group. Interestingly, Powell never made use of the word recession, but did acknowledge that there will likely be a period of sustained period of below trend growth. When asked about cutting rates, Powell stated that the FMC would need to see below trend growth and more balanced labor market and clear evidence that inflation is heading back toward its 2% target before considering such a move. This is not expected to come soon as Powell stated we are just entering the lowest level of restrictive.

    In addition, little mention of the balance sheet runoff suggest the committee will maintain its current pace of QT for now. For investors since the August CPI report, rates have adjusted higher reflecting the more hawkish path for interest rates. Given this, the short term outlook for equities remains challenging while high quality intermediate to long duration core bonds may be the most attractive sector is within a fixed income.

    The Federal Open Market Committee (FOMC) voted unanimously to raise the Federal funds rate target range by 0.75% to 3.00%-3.25%. The tone of the committee remains hawkish given policymakers are “highly attentive” to taming inflation that runs well above its 2% target. Strong job growth and persistent excess demand for labor suggest a soft landing is still possible.  However, aggressive Federal Reserve (Fed) tightening keeps the probability of recession sometime next year elevated. 

    The committee delivered forward guidance through its Summary of Economic Projections (SEP) and provided a much more hawkish median “dot” plot. Relative to their June forecasts:

    • The FOMC sees the federal funds rate ending 2022 at 4.4% and hitting a 4.6% terminal rate in 2023, with rates remaining restrictive until at least 2025.
    • Real GDP growth projections were revised lower from 1.7% year-over-year in 4Q22 to just 0.2%, and cut to 1.2% by 4Q23, followed by a more sustainable 1.5%-2.0% through 2025.
    • Expectations for year-over-year PCE deflator inflation for 4Q22 were revised higher with headline up to 5.4% from 5.2% and core up to 4.5% from 4.3%. Thereafter, inflation is still expected to cool steadily through 2025.
    • The 4Q22 unemployment rate forecast was nudged up to 3.8% compared to 3.7% in June. 2023 and 2024 forecasts saw more significant boosts to 4.4% in each year from 3.9% and 4.1% respectively.

    In our view, the key messages from the updated SEP and dot plot are:

    • Sticky inflationary pressures in owners’ equivalent rent (OER), rental CPI and wage growth will keep core inflation stubbornly elevated into next year, while declines in energy and US gasoline prices should lead to a larger decline in headline consumer prices.
    • The slide seen in both real GDP and productivity in the first half of the year do not reflect an economy in recession. That said, the committee recognizes that businesses and consumers will come under pressure as the economy enters a period of higher rates.
    • The persistent excess demand for labor is expected to the keep the rise in the unemployment rate modest, but higher unemployment is a necessary evil to kill inflation.
    • The committee will lift rates to 4-5% next year and doesn’t expect to begin lowering rates until 2024. 

    The statement language was nearly identical to July and notably reiterated that “ongoing increases in the target range will be appropriate”, keeping the door open for another 125 bps in increases by year end.

    At the press conference, Chairman Jerome Powell repeated his Jackson Hole messaging, noting that restoring price stability will keep rates restrictive for “some time”, but at some point, a slower pace of rate hikes “will become appropriate”. For now, the FOMC remains laser focused on inflation and keeping inflation expectations anchored. Interestingly, Powell never made use of the word recession, but did acknowledge that there will likely be a period of “sustained period of below-trend growth”.  When asked about cutting rates, Powell stated that the FOMC would need to see below-trend growth, a more balanced labor market and clear evidence that inflation is heading back towards its 2% target before considering such a move. This is not expected to come soon as Powell stated we are just entering the “lowest level” of restrictive. In addition, little mention of the balance sheet runoff suggests the committee will maintain its current pace of QT for now. For investors, since the August CPI report, rates have adjusted higher, reflecting the more hawkish path for rates. Given this, the short-term outlook for equities remains challenging while high-quality intermediate to long duration core bonds may be the most attractive sectors within fixed income.

    Markets brace for higher for longer.

    U.S. Implied Policy Rate (%)

    Source: Bloomberg, Federal Reserve, J.P. Morgan Asset Management.
    *Forecasts of 18 FOMC participations, median estimate. **Green denotes an adjustment higher, red denotes an adjustment lower.
    Data are as of September 21, 2022.

    09pf221602182411

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