The Fed paused its rate hike again in its latest FOMC meeting. This is the third rate pause in its last three consecutive meetings. It is not a surprise; the market has expected the Fed to pause this month. However, we saw a surprising projection from the Fed minutes, which may indicate the Fed is ready to pivot soon.
Where Are We With Inflation?
US CPI inflation has cooled down this year. The latest CPI reading in November 2023 was 3.1%. Core CPI was 4.0%. These numbers are way down from the 9.1% and 6.6% we saw in 2022. Although we cannot say we have won the inflation battle, it seems we are heading in the right direction.
The Fed’s Latest Rates Projection
Due to the cooling inflation, the market expected the Fed to hold the interest rate steady in this December 2023 FOMC meeting. And as expected, the Fed kept the rates steady. This is the third consecutive rate pause. Powell iterated that they are still keeping rate hikes on the table for now. However, we saw a bit of a surprise from their projection for future rates.
From the FOMC minutes, we can see that the median expected federal funds rate for the end of 2023 is already at the level we are currently in. The Fed no longer expects any more rate hikes! This latest projection is 25bps lower than their projection in the September FOMC meeting. The median end-of-the-year 2024 rate is at 4.6%, around 75bps lower than the current level, indicating three rate cuts in 2024. This is 50bps lower than what they projected back in September. The Fed’s projection shows that they believe they have reached the end of this rate hike cycle and will start to pivot in 2024.
Market’s Rates Projection
What about the market? Do they agree with the Fed’s projection?
Okay, the market is even more aggressive, expecting seven rate cuts by the end of 2024! The end-of-the-year rate is expected to be around 3.50-3.75%. That is 175bps lower than the current rate!
Regardless of whether or not the expectation is too aggressive, it appears that the market also expects that we have reached the end of this rate hike cycle and that rates will begin to reverse in 2024.
No Recession?
Almost every economist expects to see a recession anytime soon. Our yield curve is also very inverted, historically signaling an incoming recession. Yet, the above projections seem to indicate that we will only get a soft landing, meaning inflation will cool down while the economy still grows. This is the best-case scenario. But how realistic is this soft-landing expectation?
We don’t know. Nobody knows with certainty. But it doesn’t matter to us because we want to position ourselves to prepare for both scenarios.
What Would We Do?
Lower rates usually correlate with the risk-on economic environment. This means risk-on assets tend to outperform. The catch is that a recession may cause these risk-on assets to underperform in the short term. They should continue to perform well in the long run because the Fed will likely cut rates even faster should a recession arrive.
We see this potential recession as yet another opportunity to accumulate more assets at a discounted price. Whether or not a recession arrives, we should prepare and position ourselves accordingly.
To protect the potential downside from a recession, we entered into a ‘bond price’ trade as covered here. Should the Fed start cutting interest rates, bond price, which has an inverse relationship with bond yield, will climb. We have accumulated TLT (US Treasury ETF) to benefit from the incoming rate cuts while protecting us from the possible economic downturn. That said, TLT has risen significantly recently and may be due for a correction. Please exercise prudence when trading or investing.
Additionally, in the past two years, we have accumulated various assets, such as stocks and REITs, to take advantage of the lower valuation of those assets.
As a reference, despite the recent rebound, Singapore REITs are still hovering way below the levels in recent years. Should the interest rates continue to fall, REITs may continue to perform well in the long term. But as always, we are only interested in the fundamentally strong REITs that are well-equipped to weather any potential downturn or prolonged high-interest rate environment. If you prefer a more diversified exposure to the Singapore REITs sector, you may also consider investing in Singapore REIT ETF.
What if a recession comes? Well, that will become another opportunity to accumulate even more! Regardless, we will continue accumulating these assets going forward using the dollar-cost-averaging approach, as we believe they will continue to perform well over the long term.
