BIL - Brake Lights At The Fed
Summary
- Last week’s Federal Reserve meeting provided reinforcement for those anticipating slower rate hikes and a more stable bond market next year.
- Chair Jerome Powell seems to lean toward downshifting to 25-basis-point increases.
- Investors could see slower rate hikes from here, though central bankers still have an off-ramp.
By Ashok Bhatia
Investors could see slower rate hikes from here, though central bankers still have an off-ramp.
Last week’s Federal Reserve meeting provided reinforcement for those anticipating slower rate hikes and a more stable bond market next year. In his comments, Chair Jerome Powell seems to lean toward downshifting to 25-basis-point increases to the federal funds rate, starting at the central bank’s next meeting. That said, he gave the impression that the committee is “feelings its way” and leaving its options open.
How many 25-bp hikes might we get early in 2023? The answer remains unclear and likely data dependent. However, at the margin, Powell’s comments seemed to reflect increased emphasis on the lagging impacts of rate increases and the existence of two-way risks of inflation and economic softening – a marked contrast to his previous hawkish tone. That said, the committee plans to shift its analysis from solely focusing on inflation to incorporating wage growth trends as well. After all, although goods and housing prices may have turned the corner, the tight labor market may translate into persistent services (ex-housing) inflation, which could take time to come down.
Overall, the FOMC’s “dot plot” suggests a terminal rate of 5.0 – 5.25%, or three more 25-bps increases – about one more hike than the bond market is currently pricing in. Moreover, policymakers are setting a high bar for interest rates cuts next year, contrary to what many investors expect. The group’s economic projections imply that they are willing to keep the funds rate at its peak terminal rate through the end of 2023 despite a potentially higher unemployment rate of 4.6% and below-trend growth of 0.5%.
All told, barring some truly surprising data, the Fed seems likely to maintain its 25-bps pace until there is more downward pressure on inflation. From this, a key implication is the potential for reduced market volatility. For example, while the U.S. 10-year U.S. Treasury yield jumped about 300 basis points this year, we could see a much smaller range in 2023 – providing a smoother ride for investors, albeit with the potential for the Fed to change course if price conditions don’t continue to improve.
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Brake Lights At The Fed