Weekly Market Update September 22, 2023
Dow Jones Industrial 33,964 -1.9%, S&P 500 4,320 -2.9%,
Nasdaq Composite 13,212 -3.6%, US Two Year 5.13%, Crude Oil $90.34
This week's headlines centered around the Wednesday Federal Reserve meeting and Powell's messaging on interest rate expectations. While the Fed left rates unchanged (expected), the Fed's forecasts for rates indicated that there will be one more 25 basis point hike this year. Equally important is the messaging that while the Fed sees interest rate cuts in 2024, there will likely be fewer than expected, with officials now predicting only two quarter-point cuts next year. Interest rates ended the week higher, and equity markets sold off on the news.
Below is a chart of the Fed's updated "Dot Plots," a collection of where each FOMC member thinks interest rates will be at the end of the current year and 2 to 3 years out into the future.
As you can see, the collective opinion within the Fed is that rates will be elevated for longer than previously expected. So, while Powell's messaging of being resolute in the war against inflation was not a surprise, the market was taken aback by the new future interest rate forecasts.
Over the past year, market participants have become ardent followers of monthly economic indicators, such as CPI (Consumer Price Index), PPI (Producer Price Index), and PCE (Personal Consumption Expenditures), as key measures of inflation. These indicators give a monthly read on inflation for both consumers and producers within the economy. It is also important to monitor what elevated interest rates will do to companies that are funding their operations through debt financings. Below is a chart showing the percentage of outstanding Investment Grade Debt in the US that will need to be refinanced in the next five years. This is often referred to as the "wall of refinancing" that companies face in a higher interest-rate environment.
To put some dollar figures on this, Goldman Sachs indicates that corporate debt maturities will be "$230 billion for the rest of 2023, $790bn in 2024, and $1.07 trillion in 2025, representing 16% of all corporate debt. There's another $4+ trillion in corporate debt set to mature from 2026 through 2030..." (Source: Goldman Sachs, Yahoo Finance).
Higher rates will lead to more expensive refinancings, and this will lead to higher corporate bankruptcies as we enter 2024 and 2025 (if rates continue to remain elevated). The Federal Reserve knows this, and as we wade into this "wall of debt maturity," there will be more dramatic impacts on the economy than we have seen up until now. One of the biggest challenges the Fed faces is that the pace of "disinflation" (slowing of inflation) is not happening quickly enough to warrant the end of rate hikes or the end of elevated rates. As we enter 2024, this problem will likely go away - in other words, the "bite" of higher rates will begin to show itself in a more dramatic fashion through corporate bankruptcies and layoffs than we have seen up until now during this rate cycle.
Ironically, this is not a negative for equities. The Fed has proven itself to be data-dependent. The Fed will react if there is evidence that a higher-rate environment is sending the economy into a downward spiral. Remember, while inflation is cooling slower than Powell and the Fed hopes, it IS slowing. The Fed has to keep its messaging clear that their first priority is to battle inflation.
But make no mistake, this Fed does NOT want to destroy the economy. When it becomes clear that higher rates are creating job losses and corporate bankruptcies (which, unfortunately, it will), this Fed will react. And the new messaging will then become "higher for shorter" and "rate cuts sooner." When this happens, both equities and bonds will rally. The key is ensuring you are invested in the market when this time comes.
Have a wonderful weekend,