• Fed Funds overnight range increases 0.75% to 3.00 – 3.25%
• FOMC projections show Fed Funds at 4.4% by December 2022 — another 1.25% still to go
• New SEP shows higher terminal rate and higher rates sooner
• Forecast target peak rate of 4.6% in Q1 2023 
• Balance sheet reduction as planned

Tic-tac-toe

Three in a row! Following market expectations, the FOMC raised the overnight Fed Funds target by three-quarters of a point today. This is the third consecutive 75 basis point (0.75%) increase by the Fed. The unanimous vote supported the Committee’s view that they are “strongly committed to returning inflation to its 2 percent objective.” Recall that they raised the short-term target from March’s 0.25 – 0.50% to today’s 3.00 – 3.25%. This unprecedented pace must be evaluated as to potential lagging impact.

The press release opened with the sentence: “modest growth in spending and production” and cited “robust job gains in recent months.” This is in contrast to last meeting’s: “recent indicators of spending and production have softened.” They have seen the signs of strength in the economy and are committed to the inflation battle. This comment was the only change in the statement from the July 27 meeting.

They continue to say if the economy were to slow down, the Fed may adjust how fast or how far it goes in raising interest rates. The Committee reiterated that it is determined to bring inflation down and that it “is highly attentive to inflation risks.” 

The focus

Chairman Powell reiterated in his press conference that lowering inflation is still the primary goal, and he is not changing the stance that he has taken since the Jackson Hole conference.

Personal Consumption Expenditures (PCE) Core Deflator is still running at 4.6%, some distance from its 2% target. Consumer Price Index (CPI) in August is running at 8.3% on a year-over-year basis. Core CPI is running at 6.3% on a year-over-year basis. They recognize that inflation is a concern for consumers and businesses. This is why they are stating their commitment, understanding the need to get this under control to avoid long-term consequences of higher prices. 

Markets sense that inflation is going to stick around and believe the Fed will continue to increase rates. The Fed’s next meeting announcement will be on November 2. Futures contracts project at a 70-basis point at the current time. Longer term projections show Fed Funds rates at 3.9% in 2024 and 2.9% in 2025. 

Reaction

UST rates have increased ahead of the FOMC meeting, listening to the President and Fed Governor’s speeches. Their consistent message is a commitment to fighting inflation. 2-year UST rates have risen over 50 basis points since early September and 10-year UST has risen 35 basis points over the same time. After today’s announcement, we have seen rates out to five years increase by approximately 5 basis points, in response to more aggressive rate hikes for the rest of the year. Long-term rates have fallen slightly, still expecting the Fed to have success in its inflation battle.

Equity markets sold off initially due to the more aggressive short-term rate expectations. After evaluating the press release and Chair Powell’s press conference, stocks have moderated. The comments about “modest growth” and “robust job gains” show we still have a strong underlying economy. We expect consolidation around these levels, watching upcoming data for signs of abating inflation. 

Summary

The Fed is doing what it has to do, given the tools it has to use. It is committed enough to fighting inflation to possibly push the economy into “below trend growth,” in order to have a stable economy long-term. Consensus is that the underlying strength of the economy will help this be a short/shallow slowing.

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Mark Frears is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Science from The University of Washington, and an MBA from University of Texas – Dallas.

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