The Federal Reserve held its key interest rate steady for a second consecutive meeting, but did not to rule out another increase amid persistent inflation. Anthony Okolie speaks with Hafiz Noordin, Portfolio Manager, Active Fixed Income, TD Asset Management about the Fed’s decision and its commitment to bringing down inflation.
As expected, the Federal Reserve held its key rate steady at a 22-year high. Hafiz, did anything stand out for you today? And do you think the Fed is done with further rate hikes?
Well, there wasn't a whole lot that happened at this meeting, and the market actually really wasn't expecting too much. So indeed, they kept their rates steady. That was pretty much what was priced in. The statement that was released also was very little change.
But one notable addition to the statement was the acknowledgment that financial conditions have tightened, so that's kind of a fancy way of saying that bond yields have obviously gone up at the 10-year and 30-year part of the curve for a number of reasons.
But at the end of the day, that's going to be causing a little bit more pain for borrowers. And so the Central Bank can keep rates where they are, pause, and watch how things evolve. And I think what we're seeing in terms of market pricing is that there may be a chance of a further rate hike in December. It's about a 25% chance that's priced in. The Fed itself really is trying to acknowledge that they have optionality to go or not go based on how the data evolves over the next month.
OK, so now you mentioned optionality. What are US bond yields telling us about the Fed's next move?
So I mentioned at the front end of the curve that really prices in the expectations for the Fed pricing in that 25% chance of a hike for December, but beyond that, really not much more and that the Fed is essentially done, and that rate cuts could start as early as June or July of next year if inflation continues to come down in its current path.
But what has been interesting to watch today has been a big decline in longer-dated bond yields, so the US 10-year is down 12 basis points. So on any other Fed day, you might think, well, it's all due to the Fed. But really, it hasn't been.
Today, there were two major economic data releases in the morning that have been driving that move. The first was the US Treasury with their quarterly refunding announcement, so that really is the government outlining how they're going to be issuing bonds to fund their deficits and in what size. What was received well by the market was that there will be a little bit less issuance in the 10-year and 30-year part of the curve, so it takes off a bit of the pressure of rising bond yields there.
And the second data point that came out was the ISM manufacturing PMI, which is a well-followed barometer of US growth. And that did show that it was a bit of a miss, well below the 50 level, which would be more neutral. And it's at the 46, 47 area. That indicates a cooling down in growth from a forward-looking perspective.
So bonds have really been rallying based on that news and really haven't changed a lot around the Fed announcement.
OK, so you talk about the cooling in the economy. What are some of the key risks to the Fed's outlook right now?
Yeah, so I think inflation is job number one. And so in terms of what's driving inflation and perhaps the risk that inflation starts to lose momentum in terms of its decline or worst case even start to increase, what could drive that?
The risks that could drive that are really the consumer. So we've seen really strong consumption this year, healthy private balance sheets. If that keeps on going and if labor markets continue to stay tight, that would definitely be a risk to the outlook.
But the other piece that has been getting a lot more attention recently has been the government deficits. They have been driving growth as well this year, but perhaps more importantly driving concerns around borrowing needs and increasing those long-term bond yields.
So the fact that they're acknowledging that financial conditions are now an input to their calculus really means that they are really watching the evolution of government deficits and how the bond yield can handle that.
OK, now the Fed has one more meeting in December before we end the year. Are there any key indicators that you'll be watching closely as the Fed considers its next move?
Yeah, well, it's one month away. About December 13 is the next meeting, and there's a lot of data to digest until then. So next up is the labor market data. So we're getting the jobs data on Friday and another one early December.
We also have the weekly jobless claims data, which is really important to watch because it's very high frequency. It's kind of an early indicator for how the job market is trending, so that's something we're watching.
But then, of course, there's inflation. And we're getting in a couple of weeks the next CPI print for October. And the day before the December 13 meeting is another inflation print, so it'll honestly be kind of down to the wire, where the market may not have made up its mind going into that meeting. And I think we'll see, potentially, some volatility if there are surprises in the data.
So the Fed still has a lot to consider before they make that decision in December. I want to talk about the US dollar because it's been on a strong run lately, despite the worries over de-dollarization. What's driving the gains, and can the US dollar keep this rally going over the next little while?
Well, a big part of it has been the increase in US bond yields, and it's been a higher increase relative to the rest of the world. And this really has been driven partly by the government deficit issues I mentioned, but also because growth has been stronger in the US relative to Europe, relative to China and Japan and Canada.
So when you do get a higher differential in bond yields in one country relative to another, the currency of that higher-yielding country tends to appreciate. So that's been a part of the US dollar bull market that we've seen this for some part of this year.
But I think at this stage, it's being a little bit more mixed. The US dollar is a little bit more stable. If we think that US growth is coming down relative to other countries, then the US dollar could decline. But I think we have to factor in that if US growth is coming down, we also have to consider that other parts of the world, growth will be coming down as well.
So if that's happening, the US dollar might still be kind of in a bit of a range and move a little bit sideways. And I think it's also important to remember that if risk assets start to come down, the US dollar has been behaving as a risk off currency, as a bit of a hedge against risk assets. So I think it's a bit of a mixed picture from here. I'd say more tactical opportunities in currency rather than necessarily a big structural opportunity from here.
Hafiz, thanks very much for joining us.
Thank you. [PEACEFUL MUSIC]