The Issue at Hand by Madison Investments
The Federal Open Market Committee (FOMC) held the federal funds rate steady at its October meeting, suggesting that more time and “the accumulation of more information” were needed before the Committee could decide its next policy move. While market expectations initially had an October hike penciled in following the Fed’s September rate increase, the tune changed over the course of the month as numerous Fed officials pushed back against that narrative. This came despite inflation continuing to rise, its underlying drivers showing little sign of easing, and affordability remaining on the minds of voters with less than one week until the midterm elections.
In this Market Brief, Chris Aleman and Mike Sanders give their immediate reaction to the policy decision, examine its potential impact on the yield curve, and discuss what the trajectory of rates could mean for bond portfolios in the months ahead.
The Discussion
Chris Aleman: Welcome back to The Issue at Hand Market Brief. I’m Chris Aleman, and I’m joined by Head of Fixed Income Mike Sanders. Before we get started, I just wanted to say one thing. Go Brewers.
Mike Sanders: Go Brewers. Let’s hope they close it out.
Chris Aleman: All right, so the Fed just concluded its October meeting, and it was largely what we expected. Heading into today, though, I think the probability of a rate hike had fallen to less than 10%. And I think that’s a stark change from a month ago, when it was closer to 70%. I thought the change in probability was kind of interesting.
So I guess what we’re going to say is: What did we get? The Fed held rates steady. However, the drivers, I think, haven’t really changed.
So, Mike, inflation is still well above target. The contributing factors, like energy prices, the Iran conflict, AI build-out, and tariffs, are still there. They haven’t subsided. So my question to you is, was today’s policy decision significant in any way?
Mike Sanders: You set it up really well. I think it was significant in the context that inflation is above target, the labor market is stable, and the last inflation print, at least on the inflation side, was not great. So the fact that you had all of that occur and there was still no decision to increase rates—kind of punting it and asking for more information until the December meeting—was interesting. Warsh was asked that. I don’t think he had a great answer on why they were punting. They just want to have more information and make a better decision.
But the interesting thing is that you’re only going to get one more CPI release before the December 9 meeting. And so what that’s going to tell you, I’m not sure, but he, at least as of right now, wants more information before he’s willing to kind of push for more hikes.
Chris Aleman: Yeah, I think that’s what we can kind of expect from Kevin Warsh. And again, not trying to joke here, but I think what we’re also kind of expecting is a lack of commentary. So I guess I have to ask: Did anything in his statement or his comments stand out to you?
Mike Sanders: Yeah, two things stood out to me. He made a comment about watching the rate market and how it’s kind of diverged from oil prices a little bit. We’re back up to 102 in oil, and you could have argued that a lot of the driver of the rate changes was higher energy prices. But we’ve kind of diverged from that because we’re a good amount off the highs in terms of 10-year and 30-year Treasury rates.
He also made a comment about the impact of possibly higher rates on AI spending, and there’s some impact there. There’s been a lot of talk, and we’ve been kind of in that camp a little bit, that some of the AI spending is going to be insensitive to rate changes and higher rates. But he seemed to push back a little bit on that and kind of connected the dots with a shift from maybe oil prices impacting rates to maybe wider credit spreads and AI-type names driving rate differences.
Chris Aleman: Well, I know you had mentioned that, I think, in our last Market Brief. So I kind of want to gauge your thoughts on the market reaction. We’re sitting here at 4 p.m. Eastern. Is this again something you expected, or is it kind of telling you anything different?
Mike Sanders: I mean, the market was off a little bit. Rates were a touch higher before the meeting, and we’ve accelerated, at least as of right now. Rates on the 10-year and 30-year Treasuries are a little bit higher, so it’s a bit of a steepening of the yield curve.
And I think you could maybe argue that this was a little bit more dovish in terms of some of the rationale for not changing rates and looking forward at what they’re going to focus on. Different factors, et cetera, could make this a little more dovish. And if a dovish Fed in terms of rate changes is going to push interest rates higher because there might be a perception that he’s not going to fight inflation as hard as maybe he would want to, we’ll see over the coming days and weeks exactly how the market reacts. But that could be one interpretation of what we’re seeing right now.
Chris Aleman: Yeah, I think that was my initial reaction to the movement post-game, I guess. So let me recap what’s been happening over the last month, and then I want to get your take on it. I kind of like what we’ve been doing. Interest rates further out on the yield curve have become more volatile. I think the last time you and I talked at length about the drivers of long-term rates, like inflation, economic growth, fiscal deficits, et cetera.
But I guess, does today’s pause do anything to alleviate pressure on the back end of the curve? Because to me, it kind of doesn’t feel like it, but I wanted to get your take on this.
Mike Sanders: I mean, not really. The interesting thing, though, is that we are pretty significantly off the highs that we’ve had. I mean, we were in the 5.35 area on 10-year Treasuries, and now we’re in the low fives. We were at 5.65 on 30-year Treasuries, and now we’re at 5.33. So long rates have become more volatile, but we definitely are off the highs for rates further out on the curve.
And I don’t know if what was discussed today will significantly change that. I think you’ll have to see the data come out, and the Fed, like they said, wants to see more information and more data. That’s going to drive their decision. So again, we’ll see over the coming days and weeks what exactly happens with the back end of the curve.
There definitely seems to be a possibility that people were trying to make a quick dollar by extending duration and buying long bonds. But we’re definitely off the highs, and a lot of the issues that we’ve had are still out there, right? Too much spending, elevated oil prices. But at least at the moment, those don’t seem to be as big of an issue as maybe they were just a couple of weeks ago.
Chris Aleman: Then let’s stick with that. I mean, one of the things that I wanted to talk about was the fiscal side. We have midterms coming up next week, and one of the main issues on voters’ minds is affordability. So is it realistic to think that there’s an outcome in these midterms that could force the administration, I guess, to scale back some of its policies that have been driving up inflation? And along with that, as a bond manager, how do midterms factor into your thought process?
Mike Sanders: Yeah, I don’t think any real policy changes after the midterms will change a lot. I think the market has pretty much priced in what’s going to happen, and that’s probably going to be Democrats getting more seats. The number of seats, who knows? That might be market-moving, but I think in general there’s going to be a split government, right? Which, you could argue, is usually good.
Chris Aleman: Yeah, I think it’s still up in the air.
Mike Sanders: And so we’ll see how that works its way out. From a manager’s perspective, not really. I mean, it’s really, really hard to gauge any of that. And again, I think generally speaking, having both parties in control of some part of the government is usually better in the long run than maybe one party having complete control and pushing through policies.
But it’s not something that we’re super concerned about or watching closely, given the affordability issues and other issues in the economy. It would be a shock if there wasn’t a democrat majority.
Chris Aleman: Got it. Well, let’s kind of wrap things up and get back to the Fed for a second. So I guess, in the coming meetings, the expectation is for two or three more hikes in the next four meetings. Is that right?
Mike Sanders: The market is pricing in a high probability of a December move, so December 9, I think, is the date. And then two more in 2027. So three total is kind of what’s getting priced in at the moment, roughly in line with, quite honestly, what was priced in before the Fed meeting.
Chris Aleman: Let’s wrap it up. Do you have any final thoughts? If not, I had a question for you personally.
Mike Sanders: No, not really.
Chris Aleman: So I guess my thing was, after listening to the press conference, one of Warsh’s comments was that he was going to cut back on the number of meetings where members vote on rates. For me personally, I took that as a bit of a surprise. So is this kind of what we should expect during Warsh’s tenure, or was this a bit of a shock to you as well?
Mike Sanders: Well, there was chatter in the market. It’s a good question. There was chatter in the market about the Fed reducing the number of meetings over the next couple of years, just because I don’t think he likes getting up there and talking about some of this policy minutiae, if you will.
So it was not shocking that there was some adjustment to it, because there had been discussions that I had read. I think, if I’m quoting this correctly and I know exactly how this is going to work, there’s going to be eight meetings, and one of those eight next year will be different. It won’t be a rate-setting meeting, if you will. Then, the following year, in 2028, six of the eight will be rate-setting meetings.
We’ll see how it plays out. My guess is that that other meeting won’t be until the second half of the year. So we’ll have some time, probably, for everybody to ask more questions about exactly what he meant in terms of the outcome of that other meeting. But yeah, it was definitely not a shock, but definitely something different.
Chris Aleman: Yeah, definitely. Well, thanks again, Mike, for joining, and one last plug: Go Brewers!
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