• Fed Funds overnight range increases 0.75% to 1.50 – 1.75%
• Projections show Fed Funds at 3.4% by December 2022 — 1.75% still to go
• Forecast target peak rate of 3.8% in 2023
• Balance sheet reduction begins this month

Statement

The FOMC raised the overnight Fed Funds target by 75 basis points (bp) today. This sends the message that they are “strongly committed to fighting inflation.” They have left the window open for 50 and 75 bp rate hikes at future meetings; they will evaluate current conditions to make the best decisions.

A week ago, the probability of the FOMC raising their target Fed Funds rate by 75 bp was only 4%. After a Consumer Price Index (CPI) release that continues to show inflation running hot and a University of Michigan Consumer Sentiment at a 40-year low, the hawks started to circle. Prior to the meeting today, probability moved up to 98%. 

The Fed’s statement recognized “inflation remains elevated, reflecting supply and demand imbalance related to the pandemic, higher energy prices and broader price pressures.” Chairman Powell also acknowledged the underlying strength of the economy, deeming it able to withstand the tightening financial conditions. He also emphasized that this is a longer-term fight and will take continued attention.

Equity markets have had a positive reaction to the news today. The more drastic rate move communicated the seriousness of the FOMC and helps the markets to remove some uncertainty. Bond market yields rose prior to the meeting with the 10y UST reaching 3.40%; prices have rallied since the announcement. The terminal Fed Funds rate is now at 3.8% vs. 3.97% earlier in the day, 10s are down around 10 bps, and rates are now lower across the curve.

Fed forecasts

Each quarter, the Committee releases its views on economic growth and statistics: the Summary of Economic Projections. The Committee believes that they will raise rates at every meeting this year, with interest rates ending the year between 3.1% and 3.9%. The median rate in two years is expected to reach 3.8%. Note this projection from the members is higher than the existing thirty-year Treasury bond yield of 3.4%. 

The Fed staff forecasts 2022 GDP to grow at 1.7%, down significantly from March’s projection of 2.8%. This decline in growth forecasts suggests staff is considering the effects of inflation and renewed lockdowns in the Far East impacting trade. Unemployment rate projections rose to 3.7% from 3.5% last quarter. The Fed recognized that our labor market remains strong. 

Balance sheet reductions will continue as planned. They do not have the immediate impact on inflation, so were not a significant part of the announcement today.

Summary

The FOMC acknowledges that this is bigger than they initially expected. It is not “transitory.” They want to slow the economy without going into recession and the markets will be looking for further signs that they can accomplish this “soft landing.” The economy is still doing well, with consumer demand strong and some slowing in the labor market. Earnings estimates for stocks will be watched closely to see the impact of rising rates but are based on solid starting levels. 

As the FOMC has projected, short-term rates will continue to increase through mid-2023. Inflation is measured in longer-term rates, and we are getting closer to the cycle highs given FOMC projections. History tells us that markets tend to be volatile in rate hiking cycles due to the tendency for recessions to follow. There remains strong demand in the economy which we believe will help offset some of the building headwinds from higher rates.

Mark Frears is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Science from The University of Washington, and an MBA from University of Texas – Dallas.

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