September Month-End Portfolio Update

Market Reaction Following the September FOMC Meeting

Since the Fed cut the federal funds rate on September 18th, a notable market reaction has been a steepening of the treasury yield curve with front-end treasury yields lower, and longer-end yields higher (see chart 1 below). This move in the curve was expected, as the Fed is forecasting additional rate cuts over the next two years. When you factor in a healthy labor market, solid profit growth, easing monetary policy by other central banks, and potential fiscal stimulus by governments such as China, the easier lending conditions and increased spending could lead to higher growth in the long-term and a potential for increased inflation.

These moves are a reminder that the Fed can’t always control the entire yield curve with their monetary policy actions. Front-end yields out to the 2-year part of the curve are primarily influenced by federal funds rate expectations, while the long end of the curve (10 to 30 years) is primarily influenced by growth and inflation expectations.

Looking ahead, the market is forecasting the 2-year yield to decline going forward while the 10-year yield is forecasted to be range-bound, causing the curve to steepen further from here (see chart 2 below).

Chart 1: Treasury Yield Curve Change since FOMC Meeting (9/17/24-9/30/24)

Chart 2: Market Expectations (as of 9/27/24)Source Chart 1 & 2: Bloomberg

Fed Speeches Support Powell’s “No Rush” Statement

Since the September 18^th FOMC meeting concluded, several Fed members have echoed Fed Chair Powell in saying that 50bp cuts are not the new expected pace, and that the Committee is in “no rush” to lower rates from here. Powell reiterated this sentiment on September 30^th when he said “this is not a committee that feels like it’s in a hurry to cut rates quickly” and will lower rates “over time.” Powell added “if the economy performs as expected that would mean two more cuts this year, for a total of 50bps more.” Here are some of the main takeaways from recent Fed speeches:

• Fed Governor Michelle Bowman:  She was the lone dissenter at the September FOMC meeting and believes the Fed should lower rates at a more “measured” pace since inflation remains a risk and the labor market is not showing a clear trend of weakness.
• Governor Waller: He would support quarter-point cuts at each of the next two Fed meetings (November and December) if the economy evolves as he expects. If the labor market worsens or inflation comes in softer, “then you can see going at a faster pace.”
• Philadelphia Fed President Harker: “The risks between our dual mandate of employment and inflation are more balanced and that’s why we’ve begun this process of bringing rates down.”
• Minneapolis Fed President Kashkari: He supports lowering rates by another half percentage point by year end. Regarding continuing with 50bp rate cuts, he said “we will probably take smaller steps unless the data changes materially”.
• Atlanta Fed President Bostic:  He fully supported the 50bp cut but expressed that it does not lock in a cadence of more 50bp moves. He also said “If the story is that inflation is continuing its drop and the labor market is staying strong, I think we have the luxury of being a bit more patient.”

However, there are also outliers such as Chicago Fed President Goolsbee who said interest rates need to be lowered “significantly” to protect the labor market and support the economy. “Over the next 12 months, we have a long way to come down to get the interest rate to something like neutral to try to hold the conditions where they are.”

GDP Income Revisions Removes “Downside Risk to the Economy”

Although the final reading for Q2 2024 GDP was unchanged at 3%, there was a large upward revision to Gross Domestic Income (GDI), which is the total income earned including wages and rental income across all sectors. This figure rose from 1.3% to 3.4% annualized. As a result, the savings rate was also revised higher from 3.3% to 5.2%. A higher savings rate means less concern that consumer spending will slow. In addition, income for 2023 was also revised up, which helps explain the solid consumer spending last year. These revisions were also noted by Fed Chair Powell as he said the “very large” revisions to income remove a “downside risk to the economy.”

Looking ahead to Q3, growth is still expected to remain elevated with market estimates ranging from 1.7% to 2% while the Atlanta Fed’s GDP forecast model is forecasting 3.1% for Q3. Another item to monitor is the dockworker strike at 36 ports along the East and Gulf coasts, which could impact the economy if it ends up being a prolonged event.