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 3.00% – 3.25%. There were no dissents.

Committee Statement:

• Economic Assessment  

  • The assessment was brief but acknowledged that inflation remains elevated, the labor market is strong, and growth is modest.

• Outlook 

  • The outlook continues to reflect upside impacts from inflation and downside impacts to growth related to the war in Ukraine.

• Current Policy and Forward Guidance

  • The Committee anticipates ongoing hikes will be appropriate as well as continued rundown of the balance sheet.

  • The FOMC remains “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 2025. Growth was again revised materially lower to 0.2% in 2022 with smaller but still meaningful downward revisions in 2023 and 2024, followed by trend growth in 2025. Unemployment is expected to rise to 3.8% in 2022 and 4.4% in 2023. 

On inflation, expectations for core PCE continued to rise in 2022 to 4.5% and 3.1% in 2023. The median of the committee continues to expect core PCE 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.

The dot plot gave us a refreshed indication of the Committee’s expectation for the pace of rate hikes which have increased materially over the quarter. The median expectations for 2022 and 2023 were revised to 4.375% (100 bps higher) and 4.625% (75 bps higher), respectively.  The median of the Committee now expects the policy rate to peak at 4.625% in 2023 and remain above the median estimate of neutral (2.5%) through 2025. The most hawkish member of the committee expects the policy rate to peak at 4.875% in 2023, while the most dovish expects the policy rate to return to a level below neutral (2.375%) by 2025

Chair’s Press Conference:

At the press conference, Chair Powell explained the rationale behind increasing the Fed Funds rate by 75 bps for a third consecutive meeting.

• Inflation : Chair Powell continues to reinforce the view that inflation is much too high, that they are attentive to upside risks, and that they want to get inflation back to 2%. They will be looking at both headline and core as well as wages. They will not overreact to one print, instead looking at 3-month, 6-month, and 12-month averages.

• Labor market : The Chair continues to view the labor market as strong with job demand exceeding supply and wage growth elevated. FOMC participants do expect this to balance out over time.

• Rate Hikes/Forward Guidance :  Depending on the data, the Fed expects that the size of rate hikes could decline at coming meetings. He emphasized the risks of easing policy prematurely but also the risk of overtightening given that policy acts with a lag.

• Economic outlook/Recession : The Fed anticipates ongoing rate hikes to reach sufficiently restrictive territory with the magnitude to be data dependent. Chair Powell emphasized that the main message from Jackson Hole has not changed: “The FOMC is resolved to bring inflation down and we will keep at it until the job is done.” To determine when they will slow and ultimately pause, they will be looking for growth below trend, a weaker labor market, and clear evidence inflation is moving toward 2%. To cut rates, they will need to be VERY CONFIDENT inflation is moving toward 2% before even considering it. He offered no explicit guidance for the November hike but admitted the SEPs imply a 75 bp hike.

• Balance Sheet : The Chair mentioned they would only consider selling securities after balance sheet runoff is well underway. At the moment, they are not considering this, nor do they expect to consider it in the near term.

Our View:

• Persistently above target inflation and low unemployment will keep the Fed on track to bring policy rates well into restrictive territory despite downside risks to growth and rising recession risks at home and abroad.

• We believe the Fed will hike to at least 4.75% before reassessing the fundamental backdrop; risks are skewed to the upside if inflation does not fall in line with market expectations.

• U.S. Treasury yields have reset substantially higher this year but should remain elevated as the Fed continues to remove policy accommodation against a backdrop of high inflation. Offsetting this upward pressure on yields from inflation and the Fed, rising recession risks, tighter financial conditions, and a slowing economy will cap how high long-end yields can rise and cause further inversion in the yield curve.  We expect the 10-year yield to end Q1 2023 between 3.375% – 3.875%.

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