All eyes were on the September FOMC meeting, where the Fed left interest rates unchanged but indicated that a further rate hike was likely before the end of the year. Fed officials revised economic projections to account for progress on inflation and the mix of stronger growth and employment data. Treasury yields rose significantly as market participants digested the higher interest rate outlook, as stocks had their worst month of 2023.
• The Federal Reserve left rates unchanged at its September 20 meeting and revised its outlook to include lower unemployment, lower inflation, higher growth, and higher interest rates compared to prior projections.
• Headline CPI accelerated on the back of higher energy prices (0.6% m/m, 3.7% y/y), while core inflation grew at a relatively more modest rate (0.3% m/m, 4.3% y/y).
• Revisions to national economic data partially eliminated the recent divergence between GDP and GDI data, with GDI data being revised notably higher.
• Home prices grew 0.9% in July, the seventh straight upside surprise.
• U.S. oil prices rose 8.6% in September, moving above $90/barrel for the first time since Nov 2022.
• Bottom-up 2023 EPS estimates for the S&P 500 marginally moved down just below $221 in September, while top-down strategist estimates moved up from $216 to $217.
• The S&P 500’s total return of –4.8% was its worst monthly performance since December 2022.
• Value stocks outperformed growth stocks by 1.6 percentage points.
• The Energy sector was the only sector with positive returns in September, the second straight such month and the third straight month of Energy outperformance.
• The Treasury curve bear steepened in September, with 2-year yields rising 18bps from 4.86% to 5.04%, while 10-Year yields rose 46bps from 4.11% to 4.57%.
• The term premium (i.e. embedded compensation for interest rate uncertainty on longer-term maturities) rose 62bps, turning positive for the first time since 2021.
• HY bonds outperformed Treasurys and IG bonds for the sixth month in a row, the longest such streak in over two years.
• Bitcoin’s 4.1% return was the digital asset’s first positive September since 2016.
First Comes the Carrot
It might feel tiring, but the Federal Reserve was a big driver of financial markets this past month, as has been the case for much of the past two years. All eyes were on the outcome of the FOMC’s meeting on September 20, and while the Fed did not actually hike rates, it still managed to tighten financial conditions. How?
The Fed basically gave the market what can be described as a carrot in the form of its economic projections — the median Fed official revised down their unemployment and inflation projections while revising up their growth and interest rate outlook. More specifically, central bankers now expect two fewer rate cuts the end of 2024.
One can speculate on the motivations of the Fed officials and if the changes to the projections are logically consistent (if the Fed believes core inflation will be lower than previously expected, why would they be slower to cut rates?) but the aftermath of the meeting was clearer.
Financial markets began to price out some of the 2024 cuts that were expected. And while Treasury yields were pushed up across the curve, the bear steepening unicorn made another appearance with longer-term Treasury yields rising more than shorter-term yields. By the time September was over, 10-year yields were at their highest levels since 2007.
Then Comes the Stick
Significant moves higher in Treasury yields often don’t occur in isolation. Remember, yields up means prices down, and while that’s specifically the case for bonds, stocks are oftentimes similarly affected as financial conditions tighten. Carrot, meet stick.
Sentiment turned decidedly risk-off as stocks had their worst month since late last year. Rate-sensitive parts of the market struggled, with the Information Technology & Consumer Discretionary sectors lagging the broader equity market.
Naturally, bonds saw their share of losses as well. Treasurys and Investment Grade bonds had their second-worst months of returns in a year. Within the Treasury market, longer duration bonds have taken it on the chin — the iShares 20+ Year Treasury Bond ETF (TLT) returned -7.9% in September.
Last month has been a microcosm of what it’s been like owning longer-term bonds during this economic cycle. Since its peak in August 2020, TLT has seen a drawdown of 48.3%. Before that, its largest drawdown had been 28.5% in 2010, nearly 20 percentage points smaller. Moreover, with three quarters of the year behind us, Treasurys are on track for their third consecutive year of losses. That has never occurred in the entire history of the United States as a nation. Talk about a stick.
Performance data quoted represents past performance. Past performance does not guarantee future results. Market returns will fluctuate, and current performance may be lower or higher than the standardized performance data quoted.