The bar to stop hiking is probably lower than the bar to cut rates
Investors have been debating whether the U.S. Federal Reserve's mandate to maintain price stability has been constrained by ongoing concerns about financial stability. Within this context, what are the implications of the bank's decision to raise rates on March 22?
Following the market volatility that ensued on the back of signs of trouble in the U.S. and European banking sectors, investors paid very close attention to what the U.S. Federal Reserve (Fed) has to say on March 22 in the hope that it could help them gauge whether recent events would affect the bank’s policy decisions moving forward.
Here are our team’s three big picture takeaways from the Fed meeting:
- The market doesn’t believe the Fed’s projected rate path over the next few years. While the central bank's expected terminal rate is now more in line with market expectations, its projected interest-rate path for the rest of 2023 and into 2025 is substantially different from market pricing.¹ Although Fed Chair Jerome Powell noted that the Fed’s base case didn’t include rate cuts, the market's base case certainly does. Who’s right?
- The Fed has incorporated ongoing turbulence in the U.S. banking sector into their deliberations and view recent developments as an alternative form of tightening. According to Mr. Powell, recent developments are roughly equivalent to a 25 basis-point rate hike. He emphasized his belief that financial conditions have tightened more than a lot of traditional financial conditions indexes have indicated. In our view, his message is that if the banking sector were to experience more stress in the weeks ahead, it could reduce the need for that ’final’ hike in this cycle.
- The Fed appeared slightly less concerned about inflation. That said, Mr. Powell was quick to emphasize that there was more work to be done. He noted that long-term inflation expectations remain anchored for households, business, forecasters, and markets. In our view, this is important because if these indicators were to move in the other direction, the Fed could turn hawkish again and the bank’s ability to slow/pause from this point forward might narrow.
We continue to believe that the Fed will be extremely cautious about cutting interest rates too soon, fearing it could trigger a reversal in inflation.
Wednesday’s decision and commentary from the Fed did little to change our views. We continue to believe that the U.S. central bank will be extremely cautious about cutting interest rates too soon, fearing it could trigger a reversal in inflation.
From an investment perspective, we think we’re at the point where embracing duration should be beneficial. The tightening of financial conditions over the past week has likely added to the expectation of an upcoming recession, which is typically followed by a drop in yields.
In terms of equities, we believe we’re likely to experience short-term volatility, as the market digests the ongoing fallout from regional U.S. banks and potential price swings in other areas of the market. As the U.S. economy digests last year’s Fed hikes, we believe inflation will continue to trend lower (our base case is that inflation will hit 4% by the end of the year).
Crucially, we expect to see multiple-expansion in the back half of this year (in anticipation of expected rate cuts in 2024), which should help propel markets higher in 2023. As always, we believe stock selection will remain key.
Important disclosures
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person.
All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management nor any affiliates or representatives (collectively Manulife Investment Management) are providing tax, investment or legal advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and its subsidiaries and affiliates, which includes the John Hancock Investment Management brand.
John Hancock Retirement Plan Services LLC provides administrative and/or recordkeeping services to sponsors or administrators of retirement plans through an open-architecture platform. John Hancock Trust Company LLC provides trust and custodial services to such plans. Group annuity contracts and recordkeeping agreements are issued by John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in NY), and John Hancock Life Insurance Company of New York, Valhalla, NY. Product features and availability may differ by state. All entities do business under certain instances using the John Hancock brand name. Each entity makes available a platform of investment alternatives to sponsors or administrators of retirement plans without regard to the individualized needs of any plan. Unless otherwise specifically stated in writing, each entity does not, and is not undertaking to, provide impartial investment advice or give advice in a fiduciary capacity. Securities are offered through John Hancock Distributors LLC, member FINRA, SIPC.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.
2809831
MGR0405232829613
