Interest Rate Market Commentary: A Hawkish Pause

September 21, 2023

There will need to be some evidence of a recession and/or lower inflation to justify interest rates moving lower.

By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone

After the Fed’s FOMC meeting and the decision to keep rates unchanged on Wednesday (9/20), 10-year Treasuries moved higher to 4.48%, a new high mark for the recent range. We were topped out at 4.34% just a month ago (8/21), followed by a few weeks of interest rates trading modestly lower. With Wednesday’s rate decision, the Fed FOMC may have kept the target Fed Funds rate the same (5.25% - 5.50% range), but left the door open for an additional 0.25% Fed Funds rate hike before year-end – possibly at the next FOMC meeting on November 1. Market participants are calling the Fed policy a “hawkish pause” and describing the Fed’s monetary policy as “higher for longer.” Fed Chairman Powell’s comments during the press conference focused on the need for Fed monetary policy to work to bring the inflation rate down to the Fed’s 2% target.

In line with “higher for longer,” the Fed’s Dot Plot (Fed officials’ survey of the expected level of the Fed Funds rates over the next few years) indicated a medium Fed Funds rate of 5.625% by year-end 2023 (indicating another +0.25%), then down to 5.125% year-end 2024 (-0.50% lower) and 4.625% year-end 2025 (-0.50% lower again). Recall that after the June FOMC meeting, the Dot Plot indicated lower Fed Funds rates by 1% by year-end 2024 and another 1% reduction in 2025. In short, expected rate reductions in 2024 and 2025 were cut in half relative to June’s Dot Plot (i.e., “higher for longer”).

Higher interest rates and the Fed’s hawkish monetary policy reflect a resilient economy and the recent August CPI inflation print (published 9/13), which shows a pick-up/reversal in the progress that we’ve seen over the past year. Top-line August CPI is at +3.7% (year-over-year) vs. last month at 3.2%. Core CPI (excluding the more volatile food and energy prices) is higher at +0.3% month-over-month; which is after two consecutive prints of Core CPI month-over-month at +0.2. Getting the core inflation from 3ish% to 2% will be more difficult than the progress made over the past year.

A number of market pundits are forecasting that 10-year rates should be at 4.50% - 4.75% to reflect expected inflation at 2.5% +/- plus spread reflecting a real return and term risk premium. There will need to be some evidence of a recession and/or lower inflation to justify interest rates moving lower.