Market Views from the Global Fixed Income, Currency & Commodities (GFICC) group

The Federal Open Market Committee (FOMC) voted to raise the Fed Funds rate by 75 bps to a target range of 1.50% – 1.75%. One member dissented in favor of a 50bps rate hike.

Committee Statement:

• Economic Assessment – 

  The assessment was brief but acknowledged the current low unemployment and high inflation backdrop related to both supply and demand pressures.

• Outlook – 

  • The outlook is less positive reflecting both the upside impacts to inflation and downside impacts to growth related to international developments in Europe and China.

  • More importantly, the Committee no longer states that they expect inflation to return to 2% and the labor market to remain strong in the face of tighter monetary policy, an admission that a soft landing will be difficult to engineer and influenced by some factors out of the Fed’s control.

• Current Policy and Forward Guidance – 

  • On the timing of future rate hikes, the Committee anticipates ongoing hikes will be appropriate as well as continued rundown of the balance sheet

  • The committee is “strongly committed” to returning inflation to target.

Summary of Economic Projections:

Investors received FOMC participants’ revised outlooks for growth, inflation, employment, and policy rates expectations through 2024. Growth was revised materially lower in 2022 by 1.1% and smaller downward revisions in 2023 and 2024. Unemployment is now also expected to rise to 3.7% in 2022, 3.9% in 2023 and 4.1% in 2024.

On inflation, expectations on core were again revised upward by 20 bps in 2022 to 4.3% and by 10 bps in 2023 to 2.7%. The median of the committee continues to expect inflation above 2% throughout the forecast horizon. Additionally, 16 out of the 18 participants who submitted forecasts view the risks to their inflation outlooks as being weighted to the upside but 2 now view the risks as broadly balanced. At the last meeting, all participants viewed risks as weighted to the upside.

The dot plot gave us a refreshed indication of the Committee’s expectation for the pace of rate hikes, which brought the Fed’s forecasts broadly in line with markets. It was a material upward revision of 150 bps in 2022, 100 bps in 2023 and 62.5 bps in 2024. The median of the Committee now expects an additional 175 bps of tightening in the remaining 4 meetings of 2022 bringing the policy rate to 3.375% by year end. The median also expected an additional 37.5 bps of tightening in 2023 to a terminal rate of 3.75% before cutting back to 3.375% in 2024. The long-run neutral rate returned to 2.5% with an additional 2 forecasters in attendance.

Chair’s Press Conference:

At the press conference, Chair Powell explained the rationale behind increasing the Fed Funds rate by 75 bps after stating that this was not something the Committee was not actively considering as recently as the May meeting. He referenced recent inflation and inflation expectations data which deviated from their expectations sufficiently enough to cause them to adjust.

• Inflation: Chair Powell opened the press conference for a second time by directly addressing the American people and highlighting that inflation is much too high. The Committee is attentive to upside inflation risks and resolute in taking action to avoid inflation becoming entrenched, specifically highlighting the University of Michigan survey of 5–10-year price expectations and the Fed’s Common Inflation Expectations (CIE) indicator, which suggested inflation expectations were drifting upward.

• Labor market: The Chairman continues to view the jobs market is “extremely tight” as reflected by the large excess of job openings relative to the unemployed. When asked about the median expectation of the unemployment rate showing increases over the next few years, he highlighted that 4.1% unemployment is still low and consistent with a successful outcome. The FOMC is not looking to create unemployment or induce a recession but views many factors impacting the outlook as out of their control.

• Rate Hikes: Chair Powell indicated that 50 or 75 bps hikes are on the table for at least the next few meetings and that they would move expeditiously. He expects that additional 75 bps rate hikes would be an “uncommon” occurrence and that they would be cautious before declaring victory on inflation.

• Balance Sheet: The balance sheet runoff would continue at caps of USD30bn and USD17.5bn per month for U.S. Treasuries and MBS respectively before doubling to $60bn and $35bn for MBS starting in September.

Our View:

• Persistently above target inflation and a strong labor market will keep the Fed on track to reset policy rates materially higher this year despite downside risks to growth and elevated global uncertainty.

• We believe the Fed will look to get to at least 3% on the policy rate as quickly as possible before reassessing the fundamental backdrop. The Fed will utilize additional 50 and 75 bps rate hikes in the last four meetings of the year, especially if the labor market remains resilient and inflation continues to surprise on the upside.

• U.S. Treasury yields have reset substantially higher so far this year but should remain elevated as the Fed continues to remove policy accommodation against a backdrop of high prices. While the 10-year Treasury can trade materially higher in the short term, we expect the 10-year yield to end 2022 closer to a range of 2.75%–3.25% as recession risks rise associated with tighter financial conditions and a slowing economy.

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