The Fed’s hawkish pause

Fed uses ‘dot plot’ to project hawkishness without a hike

• As we anticipated, the Federal Open Market Committee (FOMC) left their Fed funds rate target range (5.00-5.25%) unchanged at its policy meeting today. The decision to hold the policy rate steady was unanimous among FOMC voting members. It also maintained its current pace of balance sheet reductions (i.e. quantitative tightening).
• In a hawkish shift, the Fed’s median “dot plot,” which offers policymakers’ future rate expectations, now suggests most Federal Reserve (Fed) officials foresee the Fed funds rate rising by 0.5% more before reaching its terminal rate. In looking at all Fed officials’ rate outlooks, 12 of 18 surveyed officials see the Fed funds rate rising by 0.5% or more this year.
• In his post-decision press conference, Fed Chair Jerome Powell defended the decision to pause rate hikes by emphasizing the Fed’s need to remain data dependent. Over the next six weeks, we expect the Fed to monitor labor market and inflation data to determine the Fed’s course of action at the July 26^th meeting. We do not believe a July rate hike is a foregone conclusion.
• We believe the Fed’s decision to forego a rate hike today suggests the Fed is actively seeking an off-ramp for their rate hike campaign. However, sticky core services inflation is creating significant complications for policymakers. By projecting a very hawkish stance throughout the balance of 2023, we believe the Fed is trying to accomplish two goals at once: 1) demonstrate an ongoing commitment to bringing inflation to the Fed’s long-run 2% target; and 2) allow time to assess if the Fed’s previous policy tightening has already been sufficient to do so.
• Today’s rate meeting supports our view that the Fed will be slower and potentially later in lowering the Fed funds rate relative to previous cycles. We believe the challenges created by 42-year high inflation will have lasting effects on the Fed’s future reaction function.
• In the wake of the Fed rate decision, the U.S. Treasury yield curve “bear flattened,” with short-dated yields rising as intermediate and longer-dated fell. This reflects the risk of higher-for-longer policy rates, which, in turn, is expected to create downward pressure on both inflation and U.S. economic activity. Lastly, it is important to remember that Fed policy works with a significant and variable lag. Therefore, we have yet to see the full impact of the Fed’s policy tightening cycle which began in early 2022.

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