Written by: Brian Davies, Chief Investment Officer
Fed Chair Jay Powell, “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.”
Powell: Restoring price stability will take some time and requires using tools forcefully to bring demand and supply into better balance … likely to require a sustained period of below-trend growth
Chairman Powell’s speech on Friday morning was expected to be 30 minutes, but was instead less than 10-minutes, and he was very pointed in his comments. The Fed is 100% focused on inflation and is willing to see an extended period of below-trend GDP growth (sub 2.0%) to see inflation fall back to its 2.0% target. Coming into the speech, the bond market had expected the Fed to ease policy in 2023 by cutting rates as early as next spring. Chairman Powell put a pin in that balloon by committing to a restrictive monetary policy for as long as it takes to bring down inflation. While he did not commit to the need for substantially tighter policy moving forward, he did say tightening will take place the rest of this year. We suspect the Neutral Fed Funds rate will end the year in the range of 3.50%-3.75% (vs. 2.25%-2.50% today). While that means tightening at every meeting for the rest of the year, September will probably see the last meeting with a 75bps hike (three 25bps rate hikes). Beyond that, we expect the Fed to be dependent and reactionary to inflation data. While inflation will be slowing from its peaks this year, forecasting how fast it can decline is almost impossible. The Fed is committed to hold policy tight and wait to see inflation definitively trend lower.
We expect the Fed will continue to restrict monetary policy to lower demand across the economy. The wildcard will be the labor market. Right now, the labor market is strong and, according to the Fed, too strong. If the labor market weakens significantly in the coming months, the Fed may have to rethink its policy stance. For us, this speech reiterates that we are in the economic cycle’s late innings. As such, our investments will continue to be focused on quality, income, and securities that can produce relative minimum volatility. We will continue to monitor conditions and adjust accordingly, but as of right now it seems the tighter for longer monetary policy will be with us into 2023, and our investment positioning will reflect this.
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