Interest Rates to Stay Higher For Longer

Stocks faltered this morning (Dow -160 points; SPX -1%) following yesterday’s Fed announcement. Commodities are mostly lower as well on a stronger dollar. The bond market is selling off. I see two main reasons. First, as Ritholtz Wealth CEO Josh Brown says, “We all have to be OK with, we had a great first half of the year, and this is a little bit of giveback. September is [usually] sloppy, and this is no exception.” Second, the Fed announcement confirmed interest rates will remain higher for longer, so bond yields are repricing higher. The 10-year Treasury Note yield ticked up to 4.47%, the highest since 2007.

Oil prices are rising again and headlines are decrying the move almost as if it portends some sort of consumer doomsday. That seems like overreaction to me, though it could cause problems in the near-term. If anything in this market can be characterized as volatile or episodic, it is oil. What goes up must come down. Over the past few years oil prices have swung wildly between $16 and $122 per barrel, driven by a global pandemic, a minor war in Europe, economic growth fears and OPEC meddling. Just this year prices have fluctuated between $67 and $91 per barrel. At this point, I wonder if there is any such thing as a “normal” level. Wall Street sees oil heading higher; Goldman Sachs expects to see $100/barrel in the near future. And while the national average price of unleaded gasoline is up around $3.85/gallon, here in California the price has spiked much more quickly to about $5.50. But based on history, I don’t expect oil to remain elevated over the long run.

The Federal Reserve declined to raise interest rates again this month, judging that it may have already done enough to put inflation on a downward trajectory. This comes despite the fact that the economy has clearly been stronger than expected. Fed officials now cite “solid” economic growth vs. “moderate” in previous announcements, and this is due to “robust” consumer spending activity. They more than doubled their 2023 GDP growth forecast to 2.1% and raised next year to 1.5% (from 1.1%). At the same time, inflation expectations are falling.

Fed Chair Powell’s press conference was also encouraging. He confirmed that his primary goal is to get inflation down while engineering a soft landing for the economy. So from now on, the Fed will “move carefully” when it comes to tightening financial conditions further. That said, we’re not out of the woods with regard to inflation. The Fed’s oft-repeated target is 2%, and its preferred inflation gauge is not expected to fall to that level until 2026. So not surprisingly, the Fed expects to keep interest rates at restrictively high level until then. Generally, a stronger economy generates higher inflation and the Fed is clearly concerned about a resurgence of prices. So just because the Fed may be done with rate hikes doesn’t mean they’ll lower rates any time soon.