Quick View: The Fed holds steady on rates and its independence
John Lloyd, Lead, Multi-Sector Credit Strategies, shares his views on the Federal Reserve (Fed) decision and reads between the lines of the Federal Open Market Committee (FOMC) statement and Chair Powell’s press conference comments.
3 minute watch
Key takeaways:
- As markets had anticipated, the Fed left interest rates unchanged in the 4.25% to 4.5% range at its January meeting.
- While the FOMC statement came across decidedly hawkish, Chair Powell’s comments were far more dovish. Notably, Chair Powell was unwilling to engage on speculation around political intervention in monetary policy, signaling that the central bank intends to remain independent in its decision making.
- Fixed income is still providing a strong real rate of return. Rates are now evenly balanced, with a 4% terminal rate priced into markets and expectations for two more rate cuts in 2025. We believe investors can continue to lean into the attractive yields in U.S. fixed income, particularly on the front end of the curve where term premiums are lower.
IMPORTANT INFORMATION
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
Credit spreads: The difference in yield between securities with similar maturity but different credit quality, often used to describe the difference in yield between corporate bonds and government bonds. Widening spreads generally indicate a deteriorating creditworthiness of corporate borrowers, while narrowing indicate improving.
Curve/Yield curve: A yield curve plots the yields (interest rate) of bonds with equal credit quality but differing maturity dates. Typically bonds with longer maturities have higher yields.
The Federal Open Market Committee (FOMC) is the body of the Federal Reserve System that sets national monetary policy.
Fiscal policy: Describes government policy relating to setting tax rates and spending levels. Fiscal policy is separate from monetary policy, which is typically set by a central bank.
Monetary policy: The policies of a central bank, aimed at influencing the level of inflation and growth in an economy. Monetary policy tools include setting interest rates and controlling the supply of money. Dovish policy aims to stimulate economic growth by lowering interest rates and increasing the money supply. Hawkish policy aims to curb inflation and slow down growth in the economy by raising interest rates and reducing the supply of money.
Real return is the return on an investment after taxes and inflation.
Term premium: The extra return that investors demand for holding long-term bonds instead of short-term bonds.
Terminal rate: Economists refer to the terminal rate as the neutral interest rate where prices are stable and full employment is achieved. In other words, it is a natural interest rate that is neither accommodative nor restrictive, and as such is regarded as an equilibrium rate.
Yield: The level of income on a security over a set period, typically expressed as a percentage rate. For a bond, this is calculated as the coupon payment divided by the current bond price.
John Lloyd: Today the Fed decided to maintain the Fed funds rate, which was in line with market expectations and completely expected.
The Fed changed the language in the release around employment and inflation. They removed “labor market conditions have generally eased, and the unemployment rate has moved up but remains low” and replaced it with “the unemployment rate has stabilized at a low level and labor market conditions remain solid.” They also removed inflation “has made progress towards the committee’s 2% objective” and replaced it with “inflation remains somewhat elevated.”
Powell came across more dovish in the press conference compared to the Fed statement, which markets first interpreted as hawkish. He stated in the press conference that policy is still “meaningfully” restrictive, and he still expects that we are still set up for further progress on inflation, with rents continuing to come down. He also commented that they don’t have to be at their inflation target to continue to cut rates.
They are not in a hurry to move policy and will be data dependent. They are also monitoring fiscal policy with regard to tariffs, immigration, and regulations but have to wait and see what will be enacted given the wide range of potential outcomes. However, Powell’s comments today suggest that the Fed will remain independent in its decision making.
The market is still expecting two cuts this year in line with the Fed given that the Fed is still meaningfully restrictive. However, the Fed is most likely on pause until we see continued progress on inflation data.
Rates are balanced now that a 4.00% terminal rate is priced into the future markets and that there is very little priced into the rate market for a recession scenario.
Fixed income is still providing a strong real rate of return. Overall credit spreads are tight but are supported by strong overall yields at current levels and strong GDP growth. We still like the front end of the curve given the possibility of higher term premiums on the long end of the curve.
Related insights
3 minute watch
Key takeaways:
- As markets had anticipated, the Fed left interest rates unchanged in the 4.25% to 4.5% range at its January meeting.
- While the FOMC statement came across decidedly hawkish, Chair Powell’s comments were far more dovish. Notably, Chair Powell was unwilling to engage on speculation around political intervention in monetary policy, signaling that the central bank intends to remain independent in its decision making.
- Fixed income is still providing a strong real rate of return. Rates are now evenly balanced, with a 4% terminal rate priced into markets and expectations for two more rate cuts in 2025. We believe investors can continue to lean into the attractive yields in U.S. fixed income, particularly on the front end of the curve where term premiums are lower.