November 4, 2022
Wednesday afternoon the Fed Statement came out and it seemed, reading between the lines, that perhaps the Fed was changing their tune (Dare we say, Relenting?). As the market breathed a sigh of relief, the press conference started, and we found out Chairman Powell and the Fed are Relentless.
To summarize the Chairman: The time to slow down is coming and may be at the next meeting but that is not decided yet. More important now is how high the terminal rate will be and how long we maintain that rate. He also stated: the cumulative effect of the rate increases happens with a lag, but he needs to see inflation come down “Decisively” before they will change course. He also talked about solving the problem of “Over-tightening” is easier than “Under-Tightening”. Finally, he said the window for a soft landing had narrowed, but not closed.
So, the Fed did pivot, just not the way the market wanted. They pivoted from large rate hikes to more, smaller rate hikes, ending at a rate “Higher than we communicated last meeting”. Why? The Economy. Third quarter GDP was strong. October Employment was strong with Non-Farm payrolls surprisingly strong and the Unemployment rate at 3.7%. Not to mention the JOLTs report shows there are still more jobs open than we have unemployed to fill them. All this is strength is keeping inflation hot as shown in the September CPI numbers (See below).
Currently, the CME Fed Watch Tool indicates the Fed will increase 75 bps at the December 14th meeting, 50 bps in February and 25 bps in March of next year. While not showing signs of relenting, the market does seem to think the Fed will do those three hikes and with a terminal rate around the 5.00-5.25% level. The last time we were at 5%? 2006, when the Fed cycle topped out at 5.25%.
We are still concerned that problems in the global financial system could make our potentially mild recession worse, but rates are attractive today. US Treasuries are at levels not seen since 2007. Looking at the 1-year break even yield on the 2-Year US Treasury (The yield a 1 Year Treasury would need to trade at 12 months from now to lose money), is now 9.8%. Stated a different way, you can buy a 2-year US Treasury today with a yield to maturity of 4.67% and make money over the next twelve months if the 1-Year yield to maturity stays below 9.8%. We believe that is a good balance of risk and reward.
-Peter Baden, CFA
Chief Investment Officer
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Consumer Price Index Ex Food & Energy
Monthly for the last 30 years ended 9-30-22
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Disclosures
Indexes used for AAA Municipal Yields
2 Year: BVAL Municipal AAA Yield Curve (Callable) 2 Year (Symbol: CAAA02YR BVLI)
5 Year: BVAL Municipal AAA Yield Curve (Callable) 5 Year (Symbol: CAAA04YR BVLI)
10 Year: BVAL Municipal AAA Yield Curve (Callable) 10 Year (Symbol: CAAA10YR BVLI)
30 Year: BVAL Municipal AAA Yield Curve (Callable) 30 Year (Symbol: CAAA30YR BVLI)
Indexes used for US Treasury Yields
2 Year: US Generic Govt 2 Year Yield (Symbol: USGG2YR)
5 Year: US Generic Govt 5 Year Yield (Symbol: USGG5YR)
10 Year: US Generic Govt 10 Year Yield (Symbol: USGG10YR)
30 Year: US Generic Govt 30 Year Yield (Symbol: USGG30YR)
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