Financial market activity was dominated by the Federal Open Market Committee meeting this week. As expected at the December meeting, the FOMC voted unanimously to leave the federal funds rate unchanged at a target range of 5.25 - 5.50%. The Fed acknowledged inflation eased over the past year while remaining elevated. In a dovish pivot, Federal Reserve Chairman Powell signaled that the federal funds rate is likely at or near its peak. The Fed cited that restrictive policy has created tighter financial conditions and slower economic activity, but the full effects of tightening have not yet been realized. The new Summary of Economic Projections reflected Core PCE inflation reaching the target 2% level in 2026 without a significant increase in unemployment. The Fed embraced their soft landing outlook with positive but below-trend growth estimated at 1.4% next year. The median forecast for the federal funds rate declined to 4.6% from 5.1% in the last estimate, implying three quarter-point rate cuts next year, four in 2025 and three in 2026, placing the federal funds target rate around 2.9% at the end of the forecast horizon. The market interpreted the statement as dovish, with futures contracts pricing in rate cuts sooner and more aggressively than the Fed’s forecasts next year. We believe the FOMC will loosen monetary policy in mid-2024 as inflation and economic growth continue to moderate.
Inflation data released this week provided support for the FOMC’s dovish outlook. The Consumer Price Index (CPI) increased 0.1% month-over-month and 3.1% year-over-year in November, edging down from 3.2% year-over-year in October. The Core CPI, which excludes volatile food and energy components, was up 0.3% month-over-month and 4.0% year-over-year, unchanged from October as expected. While the slowdown in the headline inflation rate was a welcome development, largely due to the decline in energy prices, shelter prices and services inflation remain stickier. Shelter was the largest contributor to November's Core CPI monthly advance, accounting for 70% of the increase. The Producer Price Index was unchanged month-over-month in November, for a 12-month increase of just 0.9%. Excluding food and energy, prices were also lower than anticipated, with the index unchanged on the month and up 2% year-over-year. Both goods and services were flat for the month.
Advance Retail Sales provided a glimpse into the holiday season this week. November sales surprised to the upside with a 0.3% increase for the month and a 4.1% gain year-over-year. Most categories in retail spending were higher in November, with advances led by motor vehicles and parts, nonstore retailers, and restaurants, offset somewhat by falling gasoline prices. Control Group Sales advanced 0.4% in November from a flat October, which led to the Atlanta Fed GDP Now Forecast increasing to an estimate of 2.6% growth in the fourth quarter. The consumer has been resilient, but we believe headwinds are mounting with lower savings rates and growing credit card debt.
Both equity and bond markets celebrated the dovish Fed announcement with significant rallies. The 2-year US Treasury yield plummeted 32 basis points this week to 4.40%, and the 10-year plunged about 32 basis points to 3.91% (as of this morning). The market will have significant data to digest next week regarding the health of the housing market, consumer sentiment, inflation, and economic growth.
Next Week:New York Fed Services Business Activity, Housing Starts and Permits, NAHB Housing Market Index, MBA Mortgage Applications, Existing Home Sales, Current Account Balance, Conference Board Consumer Confidence Index, GDP, Philadelphia Fed Business Outlook, Leading Economic Indicators, Kansas City Fed Manufacturing Activity, PCE, Durable Goods Orders, New Home Sales, University of Michigan Sentiment, Kansas City Fed Services Activity
Copyright © 2023. All Rights Reserved
© 2023 Chandler Asset Management, Inc. An Independent Registered Investment Adviser. Data source: Bloomberg, Federal Reserve, and the US Department of Labor. This report is provided for informational purposes only and should not be construed as specific investment or legal advice. The information contained herein was obtained from sources believed to be reliable as of the date of publication, but may become outdated or superseded at any time without notice. Any opinions or views expressed are based on current market conditions and are subject to change. This report may contain forecasts and forward-looking statements which are inherently limited and should not be relied upon as an indicator of future results. Past performance is not indicative of future results. This report is not intended to constitute an offer, solicitation, recommendation, or advice regarding any securities or investment strategy and should not be regarded by recipients as a substitute for the exercise of their own judgment. Fixed income investments are subject to interest rate, credit, and market risk. Interest rate risk: The value of fixed income investments will decline as interest rates rise. Credit risk: the possibility that the borrower may not be able to repay interest and principal. Low-rated bonds generally have to pay higher interest rates to attract investors willing to take on greater risk.