September 20, 2022
No Pivot at Jackson Hole
September 20, 2022
Federal Reserve Board1
While the Federal Open Market Committee (FOMC) did not formally meet in August, markets closely followed Chairman Powell’s speech at the annual Jackson Hole Economic Symposium. He reiterated that policy rates need to keep rising well above the long-term neutral rate and stay there for some time. He acknowledged that to bring down inflation households and business are likely to experience “some pain.” Chairman Powell and the committee are willing to tolerate a softer labor market and a “sustained period of below-trend growth” to lower inflation. The FOMC will remain data dependent for its September meeting and sees policy moving to “sufficiently restrictive.”
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on September 8, 2022, President Lagarde and the policy committee increased the ECB deposit rate by 0.75% to 0.75%. The Governing Council was clear in its forward guidance stating it “expects to raise interest rates further” due to inflation remaining exceedingly high. The ECB increased its inflation expectations now to 8.1% for 2022 while also lowering economic growth projections. While the committee remains data dependent and steadfast in its pursuit to curb inflation it suggests that inflation has yet to peak.
Bank of England1
At its August meeting, the Bank of England (BoE) Monetary Policy Committee (MPC) voted 8-1 to increase the Bank Rate by 0.50% to 1.75% as inflation “intensified.” The one dissenting vote preferred a 0.25% increase. Surging inflation in the U.K. can be attributed to wholesale gas prices, which have nearly doubled since May. The BoE is now expecting inflation to peak around 13% in the fourth quarter. Simultaneously, U.K. gross domestic product growth has started to decline, and the MPC now expects a recession beginning in the fourth quarter of 2022.
The July consumer price index (CPI) decelerated by more than anticipated, to 8.5% from a year earlier, with core CPI below consensus at 5.9%, while non-farm payroll reports far exceeded expectations with 528,000 jobs created and an unemployment rate of 3.5% at a half-century low. In the minutes released from the July FOMC, officials reinforced hawkish messaging, citing a desire to avoid having elevated inflation become entrenched. As of August month-end, the market is pricing in more than 1% of additional tightening throughout the remainder of the year, with over 50 basis points (bps) anticipated at the September FOMC meeting. With expectations that the Fed will continue to tighten monetary policy in the near term, we remain comfortable managing the portfolios with elevated levels of liquidity and a short duration profile. Allocations to daily resetting SOFR and OBFR floating-rate notes continue to benefit the portfolios as their coupons reprice immediately following each rate hike.
In portfolios that can do repurchase agreements, we have kept the durations on the shorter weighted average maturity (WAM) side due to the nearly immediate yield benefit of higher repo rates following a rate hike by the FOMC. The Fed’s reverse repo facility continues to take in excess of $2 trillion daily, and we believe will likely continue to climb as rates rise. We feel our portfolio construction allows us to be proactive and responsive to changes in market conditions and interest rate levels.
The front end of the AAA tax-exempt municipal yield curve saw significant upward yield pressure in August, correcting months of distorted pricing and leading to a broad “bear flattening” of the curve. At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) rose during the month of August, driven higher by Fed rate expectations. The SIFMA Index,4 which measures yields for weekly VRDOs, finished the month at 1.50%. Our portfolio is well positioned for a rising rate environment, in our view, with a short duration and high concentrations in VRDOs.