• Fed holds overnight rate range steady at 5.25%–5.5%.
• Sees economy expanding at a “solid pace” above July’s “moderate pace.”
• Fed members see rates rising into the 5.6% area, per “dot plot” in projections.
• 2024 and 2025 rate projections each rose by a half of one percent — Fed expects higher for longer.

Prepared

No surprise, the FOMC did not change its overnight Fed Funds rate range. The current rate increase cycle started in March of last year and the Committee raised rates at 11 of 13 meetings. Short-term rates remain at their highest in 22 years. The Fed will continue to draw down its bond portfolio, which pulls excess reserves from the banking system. 

The second most important point in the press release was unchanged — that they will watch the data and react:

"The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals."

Repeating that statement from prior releases telegraphs that if inflation remains elevated, the Fed will increase short-term rates.

Economic projections

The quarterly update of Committee members’ economic forecasts supported the idea that interest rates are likely staying near these levels for the time being. Economic growth, as measured by GDP, for this year increased from 1% to 2.1%. Next year’s GDP forecast was also increased from 1.1% to 1.5%. Short answer: by doubling its GDP forecast this year, the Committee does not believe that moving interest rates from one-quarter of a percent up to nearly 5.5% will cause the economy to tip into recession. 

Slightly lower economic growth next year will result in higher unemployment in the Fed’s forecast. Unemployment rises from 3.8% to 4.1% next year. 

In his press conference, Chairman Powell reiterated the Committee’s long-term goal of reaching 2% inflation and maximum employment. Clearly the Committee is conceding progress toward the 2% goal: the September 2022 forecast inflation rate was 2.3% in 2024. This year’s forecast is 2.5%. We expect the December projections update will show their inflation forecast inching higher, not lower.

We are not encouraged about the direction of inflation. Wall Street and the Fed believe that inflation will continue to coast lower toward the 2% goal over the next three years. Our reading of the inflation data suggests higher labor costs in a number of industries, especially in the auto sector. Oil supplies are tight, and the Strategic Petroleum Reserve was nearly drained by the Administration last year, leaving little domestic buffer. Medical cost inflation is set to rise next month when the BLS releases updates to the calculation method. Home-building starts continue to fall, lowering supply and supporting higher prices. All support our view that inflation will trend near 4% as opposed to 2% in the coming year. 

Summary

The FOMC has transitioned to “skip” mode, similar to Powell’s previous rate increase cycle in 2018. There are two more meetings scheduled this year: November 1 and December 13. One more increase this year would be consistent with the Fed’s end-of-year rate projections of an average 5.625%.

Market response after Powell’s press conference was muted. Two-year Treasury Note rates moved slightly higher while 10-year rates were about two-hundreds of a percent lower. Industrial and transportation stocks improved slightly on hopes that the Fed’s improved growth forecast proves correct. 

We remain on the fence, knowing the Fed is worried about wage inflation from ongoing strikes and worker shortages. We anticipate another rate increase by next February before the Fed takes a pause in front of the election. By then there should be clarity on the UAW and airline strikes, Congressional budget and borrowing, and home building.

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Steve Orr is the Managing Director and Chief Investment Officer for 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 Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here. 

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