October 27, 2023
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The Federal Reserve signals higher-for-longer interest rates
The Federal Reserve takes a pause but signals higher-for-longer interest rates to rein in inflation.
Commentary
The Fed signals higher borrowing costs aren’t going away any time soon
Fed officials held their policy rate steady in September at a 22-year high, but they
continued to forecast one more rate increase before the end of 2023. A series of
rate hikes by the central bank since March 2022 has taken the benchmark federal
funds rate to a target range of 5.25% and 5.50%,
1
the highest level since 2001.
2
In addition, the Fed’s Summary of Economic Projections
3
(SEP) for 2024 showed
officials adjusted the median fed funds rate projection higher by 50 basis points
from 4.625% to 5.125%. The move reinforces their messaging of “higher for longer”
interest rates. Market participants expect the Fed will cut rates more slowly in 2024
and 2025 than they previously expected.
Fed Chair Jerome Powell said the central bank will continue to look for evidence
the recent slowdown in inflation can be sustained. Policymakers also struck a more
balanced tone about expectations for the future rate path, with some suggesting
that it may be close to the Fed’s terminal rate. As of September 30, fed funds
futures were pricing in a terminal rate of 5.46% by January 2024, and rate cuts
starting at the end of the first quarter of that year.
At the September policy meeting, the Federal Open Market Committee (FOMC)
repeated language saying officials will determine the “extent of additional policy
firming that may be appropriate” to bring inflation to the 2% target. Policymakers
said they will consider the “cumulative tightening of monetary policy, the lags with
which monetary policy affects economic activity and inflation, and economic and
financial developments.”
Money markets
The Federal Reserve signals higher-for-longer interest rates
KEY TAKEAWAYS
•
The Federal Reserve takes a pause but signals higher-for-longer interest rates to
rein in inflation.
•
The rising supply of Treasury bills has been well absorbed by investors as more
issuance looms on the horizon.
•
Treasury bill yields have trended higher, driven by elevated Fed rate expectations
and the surge of recent supply.
•
Money market flows reached record highs in the third quarter amid volatility in the
broader asset markets.
Kerry Pope, CFA
Institutional Portfolio Manager
Money markets
|
2
Source Bloomberg Finance L.P., as of September 30, 2023.
EXHIBIT 1: The fed funds futures shift higher to reflect the Fed’s median policy estimates.
Fed Funds Futures vs. FOMC’s Forecasted Rates
While the Fed is forecasting a soft landing for the economy, the job market poses a conundrum.
Although inflation has moderated, employment data continues to surprise to the upside. For the
Fed, the labor market’s strength threatens to hinder progress on curbing inflation and adds to the
case for the central bank to hike rates further.
Market digests Treasury bill auctions as government debt and deficits balloon
During the third quarter, the Treasury Department increased its bills issuance. The bills
outstanding rose to $5.26 trillion at the end of September from $4.466 trillion at the end of June.
The increase in supply, hawkish Fed comments, and quarter-end market volatility have contributed
to higher Treasury bill yields in recent weeks.
Money market funds with access to the Fed’s reverse repurchase agreement (RRP) facility have
boosted their participation in the bill auctions. Prior to the debt ceiling resolution in June, money
market funds had increased their usage of the RRP facility in the absence of attractive alternative
investments. Since the debt ceiling was suspended, the balance at the RRP facility continued to
decline as investors piled into short-term bills. In the third quarter, the RRP balance shrunk by
about $500 billion to $1.557 trillion.
Against that backdrop, Treasury bill yields have trended higher. The rise has been driven by
elevated Fed rate expectations and the surge in bill supply to fund the U.S. government. The
annual deficit rose to $1.52 trillion
4
during the fiscal year ended Sept. 30. Net interest payments
on the federal government’s debt have surged above $600 billion a year from around $380
billion when the Covid-19 pandemic hit. Meanwhile, the maturity profile of the U.S. Treasury has
shortened in recent years; almost one-third of the national debt needs to be rolled over within the
next 12 months.
4%
5%
6%
Sep-23
Oct-23
Nov-23
Dec-23
Jan-24
Feb-24
Mar-24
Apr-24
May-24
Jun-24
Aug-24
Sep-24
Oct-24
Nov-24
Dec-24
Fed Funds Futures (6/30/23)
FOMC Dots (6/14/23)
Fed Funds Futures (9/30/23)
FOMC Dots (9/30/23)
Jul-24
Money markets
|
3
The combination of the July Fed rate hike coupled with the August Treasury refunding
announcement, where they acknowledged growing deficits would result in larger Treasury
issuance out the curve, sparked the recent rise in long-term Treasury yields. The sell-off
gained further momentum at the September FOMC meeting when the Fed’s economic
projections showed a higher projected interest rate path in 2024 and 2025.
Source: Bloomberg Finance L.P., as of September 30, 2023.
EXHIBIT 2: The yields on U.S. Treasury bills have trended higher in the third quarter of 2023.
5.0%
5.2%
5.4%
5.6%
5.8%
Jun-23
Jul-23
Aug-23
Sep-23
1 Month
3 Month
6 Month
12 Month
Ten-year bond yields soared to 4.81% in early October, the highest level since 2007. Investors worry
that sustained fiscal shortfalls on the scale projected by the Congressional Budget Office could push
rates higher still — which only puts more pressure on public finances by adding to the government’s
deficits. The Treasury, sensitive to the backup in yields, will continue to rely on issuance in the
front end of their funding curve, having recently acknowledged that the amount of Treasury bills
outstanding will eclipse the 15%–20% of total debt outstanding recommendation by the Treasury
Borrowing Advisory Committee.
Money market funds attract record inflows
Assets in money market funds climbed to a record high during the third quarter as volatility in
the broad fixed income and equity markets combined with money market yields above 5% drove
investor flows.
Money markets
|
4
During the quarter, according to data from iMoneyNet, total money market assets
increased by approximately $250 billion and for the year have increased by over
$900 billion to reach $5.506 trillion at the end of September.
Source: iMoneyNet, as of September 30, 2023.
EXHIBIT 3: Money market funds have attracted inflows from investors
Money Market Assets under Management and Average Money Market Fund Yields
See table below for key monthly macroeconomic data:
Source: Bloomberg Finance L.P. and iMoneyNet, as of September 30, 2023. * Secured Overnight Financing Rate
(SOFR). **SIFMA: Securities Industry and Financial Markets Association. *** 7-Day Yield average for institutional
category. **** Revised data from the Bureau of Labor Statistics.
3.7
3.9
4 .1
4.3
4.5
4.7
4.9
5 .1
4.5
4.6
4.7
4.8
4.9
5.0
5 .1
5.2
5.3
5.4
5.5
Dec-22
Jan-23
Feb-23
Mar-23
Apr-23
May-23
Jun-23
Jul-23
Aug-23
Sep-23
MMF Assets
MMF Yield
MMF Assets ($Trillions)
MMF Yield (%)
Key Rates (%)
July
August
September
Fed Funds Effective
5 .12
5.33
5.33
1M Bill (MMY)
5.30
5.30
5.31
3M Bill (MMY)
5.35
5.41
5.40
6M Bill (MMY)
5.41
5.50
5.46
12M Bill (MMY)
5.33
5.39
5.45
SOFR*
5.31
5.31
5.31
1M LIBOR
5.43
5.44
5.43
3M LIBOR
5.63
5.66
5.66
SIFMA**
3.98
4.06
3.98
Treasury Only MMF***
4.88
5.00
5.05
Treasury MMF***
4.81
5.03
5.05
Gov’t & Agencies MMF***
4.85
5.04
5.06
Prime MMF***
5.03
5.24
5.26
Statistics (%)
July
August
September
Unemployment Rate (%)
3.5
3.8
3.8
Non-Farm Payroll MoM**** ($ in thousands)
236
227
336
Core PCE Inflation (%)
4.29
3.88
N/A
Quarterly Statistics
Q4 2022
Q1 2023
Q2 2023
GDP YoY (%)
0.7
1.7
2.4
1
Federal Reserve, September 2023. https://www.federalreserve.gov/monetarypolicy/openmarket.htm
2
Federal Reserve, September 2023. https://www.federalreserve.gov/monetarypolicy/openmarket_archive.htm
3
Federal Reserve, September 2023. https://www.federalreserve.gov/newsevents/pressreleases/monetary20230920b.htm
4
Treasury Department, October 2023. https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/
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Author
Kerry Pope, CFA
Institutional Portfolio Manager
Kerry Pope is an institutional portfolio manager in the Fixed Income division at Fidelity Investments. In this role, he is responsible for
communicating portfolio strategy and positioning, designing customized liquidity management solutions for institutional clients, and providing
portfolio reviews.
Fidelity Thought Leadership Vice President Shanthy Nambiar provided editorial direction for this article.
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