Higher for longer – interest rate pivot postponed

In the Federal Reserve's outlook, the prediction of a "soft landing" for the economy is gaining traction. However, Chair Jerome Powell is in denial about the Fed’s soft-landing forecast.

Despite a wide range of challenges, the US economy remains resilient. Thus far, significant interest rate hikes, the collapse of the Silicon Valley Bank, as well as the deadlock over the US government's debt ceiling have left minimal marks on economic growth.

Indeed, Federal Reserve officials are increasingly confident in their ability to curb inflation without provoking a recession or a rise in unemployment. We view this as a trend-following assessment, as the Fed's own forecast was notably more cautious just three months ago. In their recently released quarterly outlook, the Federal Reserve raised its growth projections for 2024 from 1.1% to 1.5%, lowered the expected unemployment rate for 2024 from 4.5% to 4.1%, while sticking to an unchanged inflation expectation of 2.5%. In other words, despite raising interest rates even higher, policymakers now anticipate better economic growth and almost unchanged employment levels. To us, this is a contradictory scenario, especially considering historical patterns and significantly higher levels of debt across the economy.

The improved forecasts are also reflected in the dataset that was highlighted during the press conference. In a nutshell, data is signaling "higher interest rates for an extended period." The "Dot-Plot," which reflects the interest rate expectations of committee members, indicates a 2024 interest rate level of 5.1%, representing a 0.5% increase compared to the last predictions made in June. Contrary to the current market expectations, policymakers anticipate another interest rate hike this year, which would raise the benchmark rate to 5.75%. Despite this very optimistic scenario being outlined in the latest economic forecasts by policymakers, Jerome Powell clearly expressed his reservations when asked by a journalist. He refrained from committing to the statement that he expects a "soft landing" for the US economy.

It appears that central bankers have few alternatives but to consistently maintain high interest rates to avoid triggering another wave of inflation through premature easing. Therefore, the adverse economic effects of higher interest rates are likely to have a more pronounced impact with a time lag. The latest adjustment to the Fed's forecasts has taken market participants by surprise, as the timing for the expected interest rate pivot has been pushed further into the future. Particularly noteworthy is the change in the expected interest rate level. Just six months ago, the market expected interest rates to drop to 3% by the end of 2024. Following the latest Fed meeting, it is now expected that interest rates start declining by mid-2024 but are unlikely to fall below 4%. Both bond and equity markets reacted negatively to the more restrictive monetary policy outlook.

We continue to view the current interest rate levels as attractive, especially considering that some central banks, including the Swiss National Bank, consider the interest rate tightening cycle to be completed. Regarding credit spreads, we remain cautious. In the equity space, decreasing leading indicators and a low-risk premium continue to suggest an underweighting. Due to significant relative valuation disparities, we find the energy sector attractive, driven by both fundamentals and structural factors. In the realm of alternative investments, gold remains remarkably stable despite higher interest rates and a stronger US dollar. An allocation to gold provides a good diversification opportunity in the current market environment.