Federal Reserve Policy Outlook as Powell pushes back on hasty rate cuts.

By Chinedu Okoye 

Federal Reserve still Data Dependent: 

The federal Reserve seems on course to hold rates further than markets had anticipated in a bid to continue it's fight against inflation which is now well within targets. 

The Fed appears to maintain it's data dependency and the data suggests that though inflation has come down without necessarily pulling down the labor market, the economy remains strong enough to withstand these interest costs. 

For the consumer it lies in the fact that the labor market is still tight with unemployment at 3.7% as the US added 216k jobs in December 2023. For businesses it seems from the fact that the 76% of long-term debt have timed out maturities with 76% of the S&P company debt fixed ling term at previous low rates. 

The Fed's not so Transitory Stance:

There have been several arguments for inflation have propped up since 2021. The Fed initially stated that the inflation experienced then was transitory in nature, a backdrop of supply chain bottlenecks from lockdowns and the Russia - Ukrainian war. 

Contrary to what some influential economists had assumed, unemployment hasn't come down, even though the Consumer Price Index are softer, and inflation is closer to the Federal Reserve 2% target. 

Though the above present a strong case for the transitory argument of a supplyside inflation, the consistently higher increase in demand is a feature of demand push inflation. 

Rational behind the Push-back and a case for a longer pause:

The decision to hold depicts an economy strong enough to run on rates at these levels, with the Federal Reserve willing, ready and able to step in should situations demand. 

Should the labor market data soften along with rates, a rate hike is definitely in order as taken away from the Fed Chairman's commentary. The Fed is essentially waiting for the market signals of distress to act, in order not to risk cutting only to raise again as inflation persists. 

The scenario of persistent inflation is rather supported by the fact that spending levels are still high, and the consumer is in a better shape than expected. However credit card debts are high and savings rate down. 

The above means the consumer could pullback at some point, but only, as the data suggests if there is a loss of confidence stemming from a cooler labor market. In that scenario we could see a pullback in aggregate demand from as a natural consequence of prudence inculcated by household and individual spending patterns. 

Lessons from Volckers Era:

A rush to reduce rates makes it cheaper to refinance credit card and other debt and this could send prices back up and farther away from official targets and prompting a monetary policy reversal. 

There is a strong case for both supply and demand side induced inflation, this is as 2021 saw Post-Covid supply restrictions create supply chain bottlenecks, as consumers in the US and most of the G7 countries were coming out of a lockdown with lots of stimulus checks. 

Supply restrictions met a high aggregate effective demand and prices rose exponentially topping 9.1% (CPI) at some point. The Russia-Ukraine war may have added to these pressures. 

Coincidentally as these bottlenecks eased up and markets adjusted prices in the US, other advanced economies declined as well with the CPI close to official targets. But a factor pointed out by Fed officials suggests that demand has stayed elevated throughout the inflation/tightening cycle. 

The feature of a sustained demand is consistent with demand pull inflation. Thus, even though prices may have moderated with supplyside factors falling in place, demand side factors exist (strong labor market). But these pressures have been tamed by interest rates. 

The current borrowing costs from a tapped out US consumer (as depicted by savings rate declines), keeps inflation in check by preventing excessive demand from reduced borrowing costs. For this reason we opine that the Fed with regards interest rates, is going to stay data dependent on the way down as it was on the way up. 

This is in order to avoid the risk of cutting to early and having to raise rates again, as did happen in the early 1970s - 1980, under then Federal Reserve Chairman, Paul Volcker. Hence the term "lessons from Volckers era". 

Asset Class Positioning: 

Investors should keep an eye on the data and position cautiously as any change in fundamentals would greatly impact a wide range of asset classes. The most to be affected are the ones with high correlation to the interest rates. 

Treasury bills, Gold, Corporate bonds, and alternate currencies could be negatively impacted. Less leveraged companies, with relatively high cash flows and dividend paying stocks could see a boost as investors pay more attention to the value. 

Zero Analytics favor equities with the above characteristics in the industries below;

• Consumer Staples

• Information Technology

• Telecommunications

• Insurance

• Healthcare

• Pharmaceuticals

Fixed Income:

Mild exposures to value Fixed-income; i.e.,medium to long-term Treasuries, and high quality corporate bonds also seems plausible to out analysts. This is as credit quality Fr most of these companies remain fairly neutral as shown by the portion of long term deb held by S&P listed companies above. 

Cash:

Holding different forms of currency could be advantageous in a market where yields are converging. Leaving investors with sufficient liquidity to take on opportunities as they come.