Pessimism and the Fed’s ‘Hawkish’ or ‘Careful’ Pause

What do you call it when the Fed pauses its rate hikes (again), projects fewer rate cuts over the next two years and its head vows about 10,000 times to “proceed carefully” when weighing the next move? Apparently it is a “hawkish pause,” according to some observers, who blame “higher for longer” fed-funds rate projections for markets’ post-meeting slide. As always, we don’t recommend reading into one day’s market movement, especially where Fed meetings are concerned—there is just too much short-term trading action, most of it based on technical indicators and human bias. The longer term is what matters, and stocks have already shown they are over rate hikes.

Reading through the Fed’s materials, we are hard pressed to see much reason for gloom. The policy statement described economic growth as “solid” and said future interest rate decisions will depend on incoming data, which all seems benign. The “dot plot” of Fed members’ economic projections showed a median assumption of one more rate hike this year followed by two 2024 cuts and five in 2025 (presuming the Fed would move in 0.25 percentage point increments).^[i] This is less than the June dot plot’s projection of four 2024 rate cuts and five in 2025, hence the higher-for-longer characterization.^[ii] But the reasoning for this is pretty positive: Inflation projections are roughly the same as in June, but economic growth expectations are up. The Fed now sees GDP growing 2.1% this year and 1.5% in 2024, which is much better than June’s projections for 1.0% GDP growth in 2023 and 1.1% next year.^[iii] Fed people anticipate rates staying higher not because inflation will remain a pest, but because stronger growth won’t necessitate big rate cuts. Seems a-ok to us.

Not that the dot plot is an actual policy signal. As Fed head Jerome Powell took great pains to remind everyone, it is a summary of individual Fed people’s forecasts, not a blueprint. Upcoming decisions will remain dependent on the data, and the Fed doesn’t have a plan. Among the 19 Fed folk who contribute to the dot plot, 7 anticipated holding pat the rest of the year and 12 anticipated one more hike. Powell cited this fact as evidence that “what people are saying is let’s see how the data come in,” stressing the Fed is “actually in a position to be able to proceed carefully as we assess the incoming data.”^[iv]

But as is often the case where the Fed is concerned, the masses seemed set on finding the cloud in the silver lining and presuming the dot plot does indeed chart a pre-set course. Absent more Fed cuts, many argued, tighter credit would choke the economy, bringing tough times for earnings and stocks. They dismiss the recent improvement in GDP and other indicators as temporary, warning monetary policy’s innate lags mean the real impact of higher rates simply hasn’t set in. And when it does, look out.

Perhaps. But the thing is, markets are forward-looking, and we don’t think it is accurate to say they see trouble in higher rates in the US or, for that matter, other big developed markets. Exhibits 1 – 3 show the S&P 500, MSCI UK Investible Market Index and MSCI EMU Index, all in local currencies, with Fed, Bank of England and ECB rate hikes highlighted. In all cases, after the initial 2022 dive amid a plethora of fears last year, stocks rose through a flurry of rate hikes. This, despite knowing full well what everyone was saying and that monetary policy changes take several months or more to fully hit the economy. If higher rates haven’t yet deterred markets, we have a hard time seeing why strong returns from here would suddenly hinge on massive rate cuts.

Exhibit 1: The Fed and US Stocks

Source: FactSet, as of 9/20/2023. S&P 500 Total Return Index, 12/31/2021 – 9/19/2023.

Exhibit 2: The BoE and UK Stocks

Source: FactSet, as of 9/20/2023. MSCI UK IMI returns with net dividends in GBP, 12/31/2021 – 9/19/2023.

Exhibit 3: The ECB and Eurozone Stocks

Source: FactSet, as of 9/20/2023. MSCI EMU returns with net dividends in EUR, 12/31/2021 – 9/19/2023.

So we suggest tuning down Fed chatter—and for that matter, all rate hike chatter on both sides of the Atlantic. This stuff has been discussed so widely for so long that it seems unlikely any material surprise power remains. All possible outcomes have been hashed and rehashed for months on end, giving markets ample time to weigh and price them. Stocks seem to have done you a favor and scrutinized all this stuff so that you can go on with life. Might as well take them up on it.