This is the headline from CNBC on September 20, after the Federal Reserve meeting. It should come as no surprise that the Fed intends to keep interest rates higher for longer based on the current inflation rate and strong employment market. We have also been consistently in the camp of “higher for longer” as the economy continues to confound the analysts and economists that make their living prognosticating the future (not very well most of the time).
Following their two-day meeting ending September 20th, the Federal Reserve decided to not raise interest rates this month, while signaling at the same time that it may keep interest rates at a high level for longer than previously expected. The Federal Reserve kept interest rates at 5.25% for the time being, allowing the committee “to assess additional information and its implications for monetary policy.” In other words, the Fed is buying some time, trying to figure out where inflation, the labor market, and economic activity are heading.
Each quarter, the Federal Reserve releases their summary of economic projections, which essentially is their best guess on future growth of the economy and employment as well as where they think interest rates will be in 2024 and over the next several years.
Part of the surprise in the Fed’s summary was an upward revision of expected economic growth through 2025 (2.1% in 2023, double its 1% estimate in June) while revising down the projected unemployment rate (3.8%, down from 4.1% estimate in June). At the bottom of the summary above, you will see the latest projection for interest rates at the end of 2024 is 5.1, up from 4.6 in June. The projection for the end of 2025 was also raised by 50 basis points (1/2%), from 3.4 to 3.9, as economic conditions are expected to remain strong. In addition, the Federal Reserve members now expect one more rate hike this year, followed by two 25-point cuts in 2024. In June, the Federal Reserve’s projections were for four interest rate cuts. This was another factor that is contributing to keeping interest rates higher for longer with the potential for fewer rate cuts in 2024.
At the same time, though, the central bankers are projecting interest rates to stay above 5% throughout next year, though with a slight 50-basis-point cut. It’s also predicting around a 4% Fed funds rate in 2025, half a percentage point higher than its projection three months ago.
Powell also mentioned in his press conference after their decision, “We are prepared to raise rates further if appropriate and we intend to hold policy at a restrictive level until we are confident that inflation is moving down sustainably toward our objective.” He added, “Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions.”
Beyond the short term, make no mistake: The Federal Reserve used their statement, economic projections, and press conference to drive home the fact that rates will stay higher for longer. That’s a message the market is going to have to digest in late 2023 or early 2024. That creates a potential problem for stocks once the Fed signals it’s officially done—because the market will lose that positive event and be faced with the reality of either 1) sustainably higher rates or 2) suddenly slowing growth that causes rate cuts.
As has been the case all year, economic and inflation data remains the key. The Federal Reserve will be monitoring the economic data going forward to help determine if another increase in interest rates is necessary.
How does this affect our current strategy? It doesn’t. It only reinforces the strategy we have implemented since 2022: higher rates for longer, potentially, and our three-pronged strategy.
1. The first part of our strategy has been buying 3-month, 4-month, and 6-month T-Bills. The following rates are from CNBC.com on 9/21/23. We are now able to earn between 5.492% to 5.539% annualized. Our strategy has been when T-Bills are redeemed, we have been able to reinvest at the same to higher rates than before. If interest rates do stay higher for longer, then this strategy will continue to be very beneficial.
Here is a chart of the 1-year T-Bill currently yielding 5.47%. You can see over the last several months, the 1-year yield has increased from below 5% to 5.47%, the highest since December 2000.
Here is a 3-year chart of the 6-month T-Bill. Toward the end of 2022, the rate on the 6-month T-Bill has increased from 4.50% to 5.51% today.
2. Intermediate-term (12-month) bonds. Since 2022, we have been purchasing high-quality bonds from banks such as JPMorgan, Wells Fargo, Bank of America, Citigroup, and Royal Bank of Canada. When we first started buying bonds toward the end of 2022, we were receiving 4.50% on a Royal Bank of Canada bond that will be maturing on 11/20/2023. Now the most recent JPMorgan bond is being issued at 5.625% for the next 12 months. As these bonds mature at lower rates starting in November, we will be able to reinvest at higher rates over the next 12 months.
3. The third part of our three-pronged strategy has been our Leader High-Quality Income fund, which is currently paying 7.11%, and our Allspring Short-Term High Income fund, paying 6.91%. The Leader High-Quality Income Fund benefits as interest rates have risen. As a result, effective August 1, 2023, Leader High-Quality Income increased their dividend from 6.5% to 7.11%.
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