Muzinich Weekly Market Comment: Striking the right balance
Viewpoint
September 23, 2024
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In our latest roundup of the key developments in financial markets and economies, we look at the single event that dominated the week’s financial news: the Federal Open Market Committee (FOMC or Committee) policy meeting.
After eight consecutive meetings with policy rates held at restrictive levels—the last adjustment in July 2023 was a 25bps hike—the Committee decided to lower the Fed funds target range by 50bps to 4.75%-5.0%[1]. Notably, there was one dissent: Governor Michelle Bowman, who favored a smaller cut of 25bps. This marked the first dissent from a Committee member since 2005.
FOMC Projections
From the updated Summary of Economic Projections, real GDP (Gross Domestic Product) growth was revised slightly downward to 2.0% from 2.1% for the forecasted period, though it remains above the Committee’s estimated long-term potential growth of 1.8% for the US economy[2]. This indicates the FOMC remains confident in achieving a soft landing.
The core PCE (Personal Consumption Expenditures) inflation projections were revised lower by 0.2% to 2.6% for 2024 and by 0.1% to 2.2% for 2025, before settling at the Committee’s 2% target in 2026. This suggests the Committee is confident the inflation battle has been won, with inflation now well-anchored. However, unemployment projections were revised higher across the forecast period. In 2024, unemployment is expected to reach 4.4%, remain there in 2025, and then edge down to 4.3% in 2026, eventually reaching a long-term neutral level of 4.2% by 2027. This signals the Committee sees full employment as a key risk to their dual mandate.
The Dot Plot showed a slight hawkish skew. Nine policymakers projected a cumulative 100bps in cuts for 2024, while one anticipated 125bps. However, seven members favored 75bps, and two supported just 50bps. Thus, 9 of the 19 members see only one more 25bps cut, or no further cuts, for the remainder of 2024.
Chair Powell emphasized the outsized 50bps cut was likely a one-off event. He even hinted that if the Committee had received the July Nonfarm Payrolls report before their previous meeting, they might have opted for a 25bps cut.
What have we learned from this meeting?
The Committee remains data-dependent, but their focus has shifted from inflation to unemployment. Going forward, the two key reports to watch will be the monthly jobs report and the Beige Book, both highlighted by Powell as crucial in the decision to cut 50bps.
Chair Powell framed the policy moves as a "recalibration," signaling the FOMC does not intend to lag behind as new data emerges—a mistake they now admit contributed to excessive inflation as the Covid event receded. In our view, this is good news for risk assets, as it boosts investor confidence the Committee will act quickly to offset a recession, something they were not willing to do in 2023.
However, the bar has risen for loosening policy faster than suggested by the Dot Plot
Inflation must remain anchored in 2025, allowing prices to increase by no more than 0.165% per month on average. Growth must also fall below long-term potential to concern the Committee. At present this doesn’t look likely; the Atlanta Fed’s GDPNow model estimates Q3 growth has been running at 2.8%, while the Bloomberg median growth estimate for 2025 aligns with long-term potential at 1.8%[3]. Meanwhile, unemployment would need to accelerate above 4.4%, which would require the Nonfarm Payrolls report to consistently come in below 100,000 jobs created.
The Committee intends to gradually remove restrictive policies, with the neutral policy rate estimated at 2.8%. This will likely happen through 25bps cuts, with 100bps in cuts expected in both 2024 and 2025, and the remaining adjustments to be completed by 2026.
Market reactions
Reviewing market reactions, we believe the FOMC seems to have struck the right balance. Bond curves continue to normalize, with the US 10-year yield now 10bps higher than the 2-year. Volatility closed the week lower, as the event provided more confirmation, and possibly certainty, for investors. Risk assets outperformed, global equities are positive for the week, and high-yield credit outperformed its investment-grade peers. The growth-sensitive commodities markets also had a strong week.
Investors seem to agree the neutral policy rate is close to 3% but remain divided between a soft-landing scenario (the "Fed followers") and a harder landing scenario (the "Fed fighters"). However, even in the fighters’ camp—following the Committee’s successful demonstration of its commitment not to fall behind the curve—consensus leans towards faster rate cuts to neutral, with a brutal crash landing seen as unlikely. The net result is that the interest rate curve is pricing in a slightly faster cutting cycle, projecting 125bps in cuts for 2024 and neutral policy rates by mid-2025 (see Chart of the Week).
Keeping an eye on Brazil…
Neither the FOMC nor investors are anticipating a further inflationary spike. However, it’s worth noting the Brazilian central bank, which led the way in recognizing the global inflation risks post-Covid, hiked its policy rate this week.
In a surprising reversal, the Brazilian central bank raised the Selic rate by 25bps to 10.75% and adjusted its year-end forecast to 11.25%. The bank is concerned about inflation becoming unanchored, and this move is seen as a precautionary step. The key driver of these inflation concerns is government interference, with investors worried about fiscal responsibility and the government’s ability to manage sovereign debt sustainably. Comments from President Lula have also raised questions about the central bank’s independence. The incoming US administration may wish to take note, as both central bank independence and fiscal responsibility are likely to come under scrutiny once they take office.
Chart of the week: Investors price in a faster cutting profile to long term neutral policy rates
Source: Bloomberg, as of September 20, 2024. For illustrative purposes only.
Past performance is not a reliable indicator of current or future results.
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies is for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of September 20, 2024, and may change without notice. All data figures are from Bloomberg, as of September 20, 2024, unless otherwise stated.
References
[1] Bloomberg, ‘US REACT: Jumbo Fed Cut Puts Floor Under Downside Job Risks,’ September 18, 2024
[2] FOMC Projections materials, September 18, 2024
[3] GDPNow, September 18, 2024
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