Richard Schmidt

Key messages

  • The target range for the federal funds rate remains at 5.25-to-5.50%.
  • U.S. economic growth continues to be more resilient than anticipated.
  • Interest rates will likely go down in 2024.

At the conclusion of its final meeting of 2023, the U.S. Federal Reserve (Fed) decided to, once again, leave its target range for the federal funds rate at 5.25-to-5.50%. The Fed will continue to assess the lagged impact of previous rate hikes before making any additional monetary policy changes. It will also continue reducing its holdings of Treasuries, agency debt and agency mortgage-backed securities. The decision was unanimously agreed upon by all voting members of the Federal Open Market Committee (FOMC) and was widely anticipated by market participants. 

2023 U.S. economic growth upgraded

Despite noting that economic growth had “slowed from its strong pace in the third quarter,” the Fed upgraded its estimate to 2.6% for 2023 in its December projections (up from 2.1% in September). Longer-term growth expectations are little changed. Additionally, the Fed reiterated that “job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low.”

Inflation and interest rate expectations move lower

From its December projections, the Fed now expects inflation of 3.2% in 2023 (down from 3.7%), 2.4% in 2024 (down from 2.6%), 2.2% in 2025 (down from 2.3%) before returning to its 2.0% target in 2026. However, the Fed did not shut the door to further rate hikes. “In determining the extent of any additional policy firming that may be appropriate to return inflation to 2.0% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” repeated the Fed.

It now expects the federal funds rate to be 5.4% at the end of this year (down from 5.6%), 4.6% at the end of 2024 (down from 5.1%) and 3.6% at the end of 2025 (down from 3.9%). As the Fed has adjusted interest rates in 0.25% increments, this suggests that we will see three rate cuts in 2024, totaling 0.75%. Looking at the Fed’s dot plot (a chart that indicates what each member of the FOMC thinks interest rates will be at the end of the year and subsequent years), no members expect rates to move higher next year if risks that could impede attaining its goals of maximum employment and 2.0% long term inflation do not increase. Most analysts expect rate cuts to commence in March. 

Still prefer fixed income vs. equities

As the lagged impact of tighter conditions continues to materialize and is a negative to risk-on assets like equities, we remain underweight equities in portfolios that include a tactical asset allocation overlay. Although equity markets have fallen from their summer highs, they remain at loftier levels than are warranted given the economic backdrop.

Regarding fixed income, there is an opportunity to benefit from a decrease in bond yields in anticipation of rate cuts down the road. We have seen this start to play out over the past month. Given the Fed’s expectations for growth, inflation and interest rates, it can be inferred that the level of policy restriction today is likely no longer required in the future.

The Fed’s first interest rate announcement in 2024 is scheduled for January 31st.

Richard Schmidt

Richard Schmidt, CFA, is an Associate Portfolio Manager with the Multi-Asset Management Team of Scotia Global Asset Management. His primary focus is on North American equity funds and pools.