Top Charts as Fed Recalibrates: Key Takeaways for Investors

Summary:

What are the key takeaways from the latest Federal Reserve (Fed) decision? In the latest LPL Street View, Chief Economist Jeffrey Roach addresses key takeaways for investors as they consider the impact from the Fed's latest decision on interest rates and impacts on market risk appetite, and the recession risk scenario.

As of May 3, the Federal Open Market Committee (FOMC), increased its policy rate for the tenth consecutive time, pushing the upper bound of the fed funds rate to five and a quarter percent, the highest since August 2007. The biggest takeaway is from the evolution of the committee's statements over the past several meetings.

So, let's go back in time with the last few meetings and take a few quotes from those statements. In January, the committee anticipated ongoing increases in the target range will be appropriate. Then in March they thought additional policy firming may be appropriate, and in May they no longer anticipate additional tightening, but rather remain focused on economic and financial developments.

The first key takeaway is the Fed has now set themselves up for keeping their target rate unchanged in June. We already know that the Fed is monitoring the long and variable lags to monetary policy, which that's just a convoluted way of saying it takes time for the real economy to react to tighter financial conditions. So, if the Fed is concerned about the time it takes for tighter credit conditions to slow down the economy, we can infer that the Fed will be inclined to pause at the next meeting. The really good news is that the committee will publish an updated summary of economic projections at that June meeting, and that's going to likely provide greater guidance for monetary policy over the balance of 2023.

This begs the question, what about July? That meeting is in late July, and we believe that by then we'll have slower inflation and weaker job growth. Another key takeaway for investors is that the real fed funds rate is finally positive, which hasn't happened since mid-2019 and only for a brief period. And remember, the real fed funds rate is positive when the Fed's target rate is higher than the U.S. inflation rate.

Looking ahead, investors need to watch labor market conditions since that's one metric highlighted by Chairman Powell. During that latest press conference, he referenced the tight labor market as a reason to remain hawkish in the near term. So, as the Fed moves to restore price stability, they rely on a host of statistics to gauge risks to their outlook, and one metric is this openings to unemployed ratio. This metric seeks to provide a concise reading of the supply and demand of the American labor market. By measuring how many job openings exist per unemployed individual, this ratio must fall further to convince the Fed that the labor market will not create inflationary headwinds.

Let's talk market implications. Investors should know that weakening consumer data, combined with what we now know about the PCE deflator, puts the Fed in a position to reassess future rate decisions. Now the markets are convinced the Fed will cut rates. We agree, but perhaps not in the magnitude of cuts. How will markets react overall? Well, let's remember, although 2023 has its fair share of risks, we don't think markets will retest last year's lows, despite the likelihood of a recession later this year. Perhaps the relationship between the equity markets and the 1990-1991 recession is most informative for today's most likely scenario. So, as recession risks rise, we think the Fed will eventually cut rates later this year and in turn provide some added support for markets.

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