Federal Reserve likely to pause rate hike cycle, eyes on labor market and energy prices

The Federal Reserve is expected to put a halt to its interest rate increase cycle in the upcoming meeting, said Kevin Flanagan, WisdomTree’s Head of Fixed Income Strategy on Tuesday. However, the path beyond this decision remains unclear, with rising oil prices and potential inflationary effects posing challenges for the central bank.

Flanagan suggests that the surge in energy costs might be perceived by the Federal Reserve as a burden on consumers. He also emphasizes the importance of labor reports, indicating that they are always a priority for the central bank. If employment reports persist in their current trend, there might be an opportunity for the Federal Reserve to hike rates once more before year-end.

The anticipated pause in the rate increase comes after a series of rate hikes, from 25 to 50 to 75 basis points, and then back down to 25. With market expectations nearly certain of no increase, Flanagan does not anticipate any disruptions from the Federal Reserve.

Two key factors to monitor include changes in policy statement wording and dot plots. These could provide insights into the Federal Reserve’s plans for 2024. Following this meeting, attention will likely shift towards the upcoming year.

While discussing future possibilities, Flanagan does not discard another rate hike this year. He cites recent economic data indicating some acceleration due to energy prices but notes that core inflation remains relatively stable. This information could potentially hint at future moves by the Federal Reserve.

Flanagan highlights that while higher energy prices could lead to inflation, it’s uncertain whether this would prompt action from the Federal Reserve. He maintains that labor markets are more critical and if employment reports continue as they are, there may be room for another rate increase before year-end.

As we approach the fourth quarter and next year, Flanagan suggests that we may be nearing or have reached the end of rate hikes. The focus should now shift towards what will happen next.

For rate cuts to occur, Flanagan believes it would likely be driven by economic activity, particularly in the labor markets. A sudden halt or decline in payroll growth could catch the Federal Reserve’s attention. He points out a shift in market expectations and emphasizes that labor market reports will likely be the key signal for when the Federal Reserve begins to shift direction.

From a strategy standpoint, Flanagan suggests investors should prepare for higher interest rates for longer. Even if the Federal Reserve cuts rates, they are still expected to remain relatively high compared to recent years. This indicates that investors should position their fixed income portfolios accordingly heading into 2024.

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