The Decision
After hiking the U.S. Fed Funds rate at 10 consecutive meetings, today, Fed Chair Powell announced that it was time to hit the pause button. As a result, Fed Funds will remain (for at least the next 6 weeks) in the 5.00-5.25% range. The decision to remain within this range was unanimous, with no dissents. This pause comes as no surprise, as it had been telegraphed to market participants via several public speeches by FOMC members in mid to late May. Additionally, although this pause may mark the end of the current streak of rate hikes, it is not meant to signal that the Fed is ready to stop altogether. Rather, they have left the door wide open for future tightening of monetary policy should the incoming data warrant additional tightening at a later date.
There was a subtle but significant change to the FOMC statement, specifically within the following sentence: “In determining the extent of additional policy firming that may be appropriate to return to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial conditions.” The phrase “…the extent to which additional policy firming may be appropriate” was replaced with “…the extent of additional policy firming that may be appropriate,” indicating an increased likelihood of future rate hikes.
The Statement of Economic Projections (SEP)
The median dot indicating the terminal Fed Funds Rate for 2023 was revised upwards, from 5.1% (within the current range) to 5.6% (indicating that FOMC members expect, on average, TWO more hikes, then for Fed Funds to remain at this level throughout 2023). Estimates for 2023 year-end unemployment were revised down from 4.5% to 4.1%, denoting the unexpected strength present in the labor market. Additionally, this implies that any economic downturn (or recession) in H2 2023 may be less harsh than originally forecasted. I have highlighted a few of the other changes within the SEP since the last release in March.
Highlights from Powell’s Prepared Remarks and the Press Conference
From the beginning of this rate hike cycle, there were three key issues – the speed of tightening, how high we would have to go, and how long we would need to stay there. We moved very quickly in 2022, then slowed down from large 75bp increases, to 50bp, to 25bp. Today’s decision to hold rates steady (but to signal the potential need for additional increases) should be thought of as a continuation of that process.
Pausing gives the economy more time to adapt. We don’t know the full extent of the lagged effects of existing rate hikes or the tightening of credit conditions as a result of banking turmoil in March. In the context of these two variables, the decision today makes sense.
When asked about the potential for a “soft landing” – There is a path to getting inflation down to 2% without a sharp downturn. The committee is completely committed to getting inflation back down to 2% over time. Restoring price stability is our top priority.
Market Reaction
The U.S. Treasury market responded with significant upticks in yield after the statement was released, as it indicated the possibility of two more rate hikes in 2023 as opposed to just one. At one point, the yield on the 2-year Treasury note surged as much as 18bp on the news, though it later retreated to +6bp on the day.
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