CIO remains focused on equity laggards with appreciation potential, including the equal-weighted S&P 500, more defensive sectors, and emerging market stocks. (ddp)

While the decision itself was widely expected, we think Fed Chair Jay Powell's commentary and the updated Fed projections effectively confirm that the Fed's hawkish bias remains in place. That sent the 2-year US Treasury yield to as high as 5.2%, a new 17-year high, while the dollar rose against a basket of currencies, and equities slipped. Here are the key points and the investment implications:


Economic conditions have been stronger than expected. Unexpectedly robust consumer spending has helped boost GDP above prior Fed forecasts. Under new Fed projections, GDP growth is now expected to rise by 2.1% for 2023 and 1.5% for 2024 (from 1% and 1.1%, respectively). Fed Chair Powell noted that the Federal Open Market Committee (FOMC) would like to observe movements in the inflation, labor, and growth data at each meeting, since the economy is now at a point which allows the Committee to “proceed carefully.” Certainly, “the full effects of tightening have yet to be felt.” Nonetheless, the labor market is generally seen to be in a better balance, and inflation is heading toward the Committee’s 2% goal (projected by 2026).


Most Fed voters see rates higher for longer. The Fed’s hawkish tone suggests one more rate hike could be in store for 2023. The committee’s updated Summary of Economic Projections showed 12 of the 19 members expect one more rate hike by the end of 2023, taking the federal funds rate to 5.6%. While rate cuts are still expected in 2024 and 2025, the assumptions have been reduced to 50 basis points of cuts in 2024 (from 100 basis points previously), and 50 basis points of cuts in 2025 (from 120 basis points in June). This brings the projected median of the federal funds rate to 5.1% in 2024 (from 4.6% in June) and 3.9% in 2025 (from 3.4% in June).


While the dot plots suggest upside risks to interest rates, we retain our expectations that the hike cycle is likely done and for the Fed not to raise rates again. We believe a variety of factors could weigh on the economy in the fourth quarter and push the Fed to remain on hold due to below-trend growth and lower core inflation.


This would support our expectations for a period of range-bound trading in equities. We remain focused on equity laggards with appreciation potential, including the equal-weighted S&P 500, more defensive sectors, and emerging market stocks. Within fixed income, we favor high-quality bonds including US Treasuries, investment grade corporate bonds, and sustainable bonds.


Main contributors - Solita Marcelli, Mark Haefele, Brian Rose, Christopher Swann, Vincent Heaney, Jon Gordon


Original report - A hawkish Fed pauses to proceed carefully in a higher-for-longer regime, 21 September 2023.