In line with market expectations, the Federal Open Market Committee (FOMC) voted to raise the federal funds rate by 25 basis points (bps) to a target range of 4.50% – 4.75%. There were no dissents.

Committee Statement:

• Economic Assessment and Outlook

  • The economic assessment was amended slightly to acknowledge that inflation has eased but remains elevated with the committee still attentive to risks. The language around supply/demand imbalances caused by the pandemic and the war in Ukraine were removed. The labor market remains strong, and growth is modest.

• Current Policy and Forward Guidance

  • The Committee reiterated that “ongoing increases” in the federal funds rate will be appropriate as well as continued rundown of the balance sheet.

  • Additional hikes will be needed until policy is “sufficiently restrictive” enough to bring inflation back to 2%.

  • The language was amended to focus on the “extent” of rate hikes, rather than the “pace”, indicating the Federal Reserve is primarily focused now on how high they will need to go as opposed to the speed.

Chair’s Press Conference:

At the press conference, Chair Powell did not strike as hawkish a tone as the market expected; rates and equities rallied as a result:

• Rate Hikes/Forward Guidance:

  • The committee’s decision to shift to a slower pace will allow them to better “assess the economy's progress...and they will continue to make decisions meeting-by-meeting, taking into account the totality of incoming data and the outlook for economic activity and inflation.”

  • The Chair is not concerned the market is misinterpreting the Fed’s reaction function, but, rather, attributes the divergence between the market and their Dots to the market’s expectation that inflation will fall more quickly.

• Inflation:

  • They view the recent inflation data “as a welcome reduction…but need substantially more evidence to be confident that inflation is on a sustained downward path.” Coupled with other Fed speak, this may imply they are looking at run rates closer to 6 months than 3.

• Labor market:

  • The Chairman continues to view the labor market as extremely tight. “Labor demands substantially exceeds the supply of available workers, and the labor force participation rate has changed little from a year ago.”

• Financial conditions:

  • The Chair did not push back on the recent easing of financial conditions since December. Instead, he said they "haven't changed much" and that the committee is not focused “on short-term moves but on sustained changes to broader financial conditions.”

Our View:

• In 2022, high inflation and low unemployment caused the Fed to raise policy well into restrictive territory despite downside risks to growth and rising recession probabilities. Looking forward, the risks to policy are becoming more balanced. The past three CPI prints, coupled with the expected trends for further declines in inflation and for a weaker labor market, should allow the Fed to pause in Q1 2023 around 4.75-5% on the policy rate.

• While front-end yields should remain elevated as the Fed continues to reiterate its desire for sufficiently restrictive policy, more broadly, the government bond market should start to see support. The cumulative impact of tighter monetary policy will continue to slow the economy and push inflation lower, eventually leading to the consideration of rate cuts. As a result, we expect the 10-year yield to end H1 2023 between 3.00% – 3.50%, with the trading range shifting lower across the balance of the year.

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