In line with market expectations, the Federal Open Market Committee (FOMC) voted to raise the federal funds rate by 50 basis points (bps) to a target range of 4.25% – 4.50%. There were no dissents.  

Committee Statement:

• Economic Assessment

  • There were no changes to the economic assessment. Inflation remains elevated, the labor market is strong, and growth is modest.

• Outlook

  • There were also no changes to the outlook - which continues to reflect upside risk for inflation and downside for growth related to the war in Ukraine.

• Current Policy and Forward Guidance

  • The Committee continues to anticipate that “ongoing increases” in the fed 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% over time. In determining the pace of future hikes, the Committee will take into account cumulative tightening of policy which impacts the economy with a lag.

  • The FOMC remains “strongly committed” to returning inflation to target and “highly attentive” to inflation risks.

Summary of Economic Projections:

Investors received FOMC participants’ revised outlooks for growth, inflation, employment, and policy rates expectations through 2025. Growth was revised higher in 2022 but was revised lower by 0.7% in 2023 to 0.5%. Unemployment is expected to rise to 4.6% in 2023 and remain around those levels in 2024-2025. These estimates were revised higher relative to last quarter.

On inflation, expectations increased again to 3.5% on core PCE in 2023. The median of the committee continues to expect core PCE to remain above 2% throughout the forecast horizon including 2025 at 2.1%. Additionally, 17 out of the 19 participants who submitted forecasts continue to view the risks to their inflation outlooks as being weighted to the upside. 1 participant saw risks weighted to the downside. 

The dot plot gave us a refreshed indication of the Committee’s expectation for the pace of rate hikes, which have increased again over the quarter. The median of the Committee now expects the policy rate to peak at 5.125% in 2023 (50bps higher) and remain more than 50bps above the median estimate of neutral (unchanged at 2.5%) through 2025. All but 2 committee members see a terminal rate above 5%. Additionally, the median member expects 100bps of rate cuts in both 2024 and 2025, once Core PCE has fallen below 3% and the unemployment rate is at 4.5%.

Chair’s Press Conference:

At the press conference, Chair Powell did his best to strike a hawkish tone, but the market did not react:

• Rate Hikes/Forward Guidance:

  • The Fed continues to anticipate ongoing rate hikes “in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.”

  • They still left open the door to revising the peak rate HIGHER in the next SEP.

  • Chair Powell re-iterated that they will not cut rates until inflation is falling in a sustained way.

  • He also re-iterated that they are more focused on the ultimate level of rates and the length of time spent there, as opposed to how fast they get there.

• Inflation:

  • Chair Powell emphasized that the most recent inflation report WAS incorporated into the SEPs.

  • While they welcomed the October and November inflation data, they still need to see SUBSTANTIALLY MORE evidence to ensure it is on a downward trajectory.

  • They are HIGHLY focused on services ex-shelter inflation. This represents ~55% of the core PCE index and is largely a function of wages and the labor market, which they still view as strong.

• Labor market:

  • The Chairman continues to view the labor market as extremely tight; they have not seen much softening in job growth, wages remain high, vacancies are still elevated, and demand substantially exceeds supply.

• Financial conditions:

  • The Chair emphasized that the Fed is not sufficiently restrictive yet even after 425bps of hikes this year

  • Chair Powell recognized that financial conditions had eased and he pointed out that—while they are comfortable with fluctuations in the short-term, which can be ascribed to many factors—it is “important that they reflect the policy restraint that we’re putting in place to return to 2% inflation.”

Our View:

• In 2022, high inflation and low unemployment caused the Fed to raise policy rates well into restrictive territory despite downside risks to growth and rising recession probabilities. Looking forward to 2023, the risks to policy are becoming more balanced. The past two 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 4.5-5% on the policy rate.

• While front-end yields should remain elevated, as the Fed continues to reiterate it's "higher for longer" message, more broadly, the government bond market should start to see support. The 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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