Jawboning
The job of the Federal Reserve Chairman is not an easy one and as Chairman Powell demonstrated at yesterday’s news conference, there are times when jawboning is just as important as policy change. The Fed left policy unchanged yesterday but Chair Powell rolled the markets through his rhetoric. Over the past few weeks, markets had boiled in a March 2024 rate cut and the beginning of an easing campaign that would last for some time. In my January 2nd comments I noted that was wishful thinking and the market was way ahead of itself as interest rates dropped by 100 basis points in December 2023. Chairman Powell stood strong yesterday and delivered that warning stating that he “didn’t think it likely that the committee will reach the level of confidence by the time of the March meeting” to justify a rate cut. Day traders were disappointed as markets fell after the conference, but I view that as short-sided.
The reality is that the economy is functioning just fine under this higher rate regime and inflation has subsided. GDP increased 2.5% in 2023 and 12-month CPI is running at 3.3%. That CPI rate is higher than the Fed’s 2% goal, but that rate will fall in the next print as the January 2023 number was hot and it will fall off on the next annual calculation. The most prudent path for the Fed is to stay the course until one of those figures breaks and I expect them to do such. It’s also an election year and the Fed wants their Apolitical reputation to be upheld. So, don’t expect a lot of Fed rate movement come November. If there is a policy change, I expect it to come from the management of the Fed’s balance sheet.
Currently, the Fed is conducting quantitative tightening by allowing the maturation of $95 billion a month of treasuries and mortgage-backed securities without replacement. That pace is nearly double the 2017 tightening cycle and it should NOT be ignored. Reducing the money supply will contract the economy, but interest rates get all the headlines. At Warcap we look under the hood and I remind investors that the Fed is reducing inflation through this secondary mechanism. From our perspective, relying on rate cuts to generate investment returns in the near term is a risk. Good old-fashioned security selection will be the key and I for one couldn’t be happier that we are back in the environment.
As always, I appreciate your continued trust and confidence.