CIO Notebook : A Pause in Hikes but a Persistence in Higher Rates

September 21, 2023

Fed Chair Jerome Powell reiterated the need to “proceed carefully.”

As expected, the Federal Reserve (Fed) announced in a unanimous decision yesterday no change in the target range of the federal funds rate of 5.25%-5.50%, following a +0.25% increase in July. Following August’s Jackson Hole event, in which Fed Chair Jerome Powell’s message emphasized data dependency and admitted that credit conditions could continue to transmit to the economy, the probability for a rate hike in this meeting declined precipitously. In addition, the likelihood of a rate hike in November – although telegraphed by the Fed in the June dot plot – also fell to less than 50% coming into this week’s meeting. In terms of changes to the Fed’s statement, we believe there were few. The Fed acknowledged that growth was solid, versus moderate, and that while job gains have slowed, they remain strong.

However, with the release of the Fed’s updated dot plot, it is clear in our view that an additional rate hike in 2023 remains very much on the table. Of the 19 members of the Federal Open Market Committee (FOMC), twelve of them expect one more rate hike this year with the other seven anticipating no movement in rates. Should the Fed determine a hike is warranted, this would likely represent the final hike in a twelve-hike cycle that began in March 2022.

Perhaps more surprising was the increase in rate expectations for both 2024 and 2025, with only two rate cuts projected in 2024 versus the previous four; implying a target funds rate of 5.1% and 3.9%, respectively, in 2024 and 2025. This is consistent with our belief that rates will be higher for longer and is likely based in part on the upward revision in GDP growth to 2.1% (from 1.0%) in 2023 and for 1.5% in 2024, the decrease in the estimate of peak unemployment to 4.1% from 4.5%, and the estimate for PCE of 3.6% for 2023 and 2.6% for 2024 as outlined in the FOMC’s economic predictions.

While Chair Powell admitted that a soft landing is certainly a plausible scenario, the implications of higher rates and higher inflation extending through 2025 are not yet fully known and the response of businesses and consumers remain uncertain. Interest rate sensitivity of the U.S. economy remains an open question, as does the appropriate level for the neutral rate in the near-term, even if the Fed continues to telegraph a 2.5% neutral rate over the long-term.

In terms of the two-way risk that we have discussed in prior notes, the FOMC now appears to see greater upside risk to inflation and lower downside risk to GDP. The implication of this assessment is that the economy is stronger than the Fed anticipated and that, as a result, bringing inflation to the target could prove more difficult. Even if we are at the end of the rate hiking cycle, we believe that quantitative tightening will continue and the need for restrictive policy remains. The restoration of price stability is, in the Fed’s view, the foundation for sustainable economic growth and that has not changed despite the economic growth delivered this year.

In summary, Chair Powell reiterated the need to “proceed carefully.” While he acknowledged that the Fed was “fairly close” to the level that the Fed needs to be at, he is clearly hesitant to declare that their work is done.


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