The Fed remains determined to fight inflation
As widely anticipated, the Federal Open Market Committee (FOMC) voted unanimously to raise the Federal funds rate target range by 0.50% to 4.25%-4.50%. The statement language was almost identical to the November statement, suggesting the committee continues to lean hawkish. It reiterated that “ongoing increases in the target range will be appropriate”, and only softened its description of upward inflation pressures by removing “additional.”
The committee delivered forward guidance through its Summary of Economic Projections (SEP) and provided a more hawkish median “dot” plot. Relative to their September forecasts:
- The FOMC sees the federal funds rate ending 2023 at 5.1%, a half-percent higher than their September forecast before reducing rates more aggressively in 2024.
- Real GDP growth projections were lowered to 0.5% and 1.6% year-over-year in 4Q23 and 4Q24, respectively.
- Expectations for the year-over-year headline and core Personal Consumption Expenditures deflator were nudged higher for 4Q23 to 3.1% and 3.5%, respectively, before trending to 2.1% by 2025.
- The unemployment rate forecast rose to 4.6% in 2023 and 2024 compared to 4.4% in September.
In our view, the key messages from the updated SEP and dot plot are:
- The range of fed funds estimates for 2023 is quite narrow with only two members seeing policy rates below 5% next year. This suggests a higher terminal rate at or above 5% will be reached in 1H23.
- The committee is all but cementing a need for below-trend growth and a pickup in unemployment to meet their objectives, but that a soft landing is still possible.
- The persistent excess demand for labor is expected to keep wages and core services (ex-housing) inflation elevated. Therefore, while the rise in the unemployment rate could be modest, it is a necessary evil to kill inflation.
We now expect the Federal Reserve (Fed) to raise rates by 0.50% in early February and by 0.25% on March 22nd before pausing, though a shift down in the size of rate increases as signaled in the press conference could see the Fed raise rates in 25 basis point increments over the first three meetings of the year.
Given the U.S. market reaction after the FOMC meeting, we expect Asian markets to end the week with more cautious tone. We would need weaker inflation data in order for the Fed to tone down its hawkishness. We maintain our view of staying cautious with a greater emphasis on fixed income, in case the Fed’s tightening leads to further deceleration in economic growth in the U.S. and weaken corporate earnings. That said, the medium-term prospects of China’s economic reopening and Asia’s domestic demand resilience could be a bright spot as the U.S. and Europe face more growth challenges.