•    Fed Funds overnight range increases 0.5% to 4.25% – 4.5%
•    Projections show Fed Funds average 5.1% for all of 2023 
•    “Ongoing increases in the target range” — more rate increases coming
•    Balance sheet reduction continues — over $1 trillion in 2023
 

As expected…

Following market expectations, the FOMC raised the overnight Fed Funds target by one half of a percent today. This is the sixth half-percent increase in the last 30 years. The unanimous vote supported the Committee’s view that they are “strongly committed to returning inflation to its 2 percent objective.” Rate increases from March’s 0.25% – 0.5% to today’s 4.25% – 4.5% represent the fastest pace of increases since 1980. 

The press release left in the sentence from prior meetings that “ongoing increases in the target range will be appropriate …to return inflation to 2 percent over time.” This is Fed-speak warning markets that rate increases will continue, likely at each meeting. The level of increases may be smaller, perhaps only one-quarter of a percent, but they are not stopping anytime soon. 

Also, the statement repeated that the Committee’s decisions are “data dependent.” In other words, if the economy continues 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.” 

Projections

Today’s meeting also included the quarterly update to the Fed’s economic projections. A majority of Committee members think Fed Funds will average 5.125% for all of 2023. This implies a smaller range of further increases from 2022’s banner acceleration from 0% to 4.25% in the lower bound. To get to 5.125%, one path could be half-point increases at the first two meetings and letting the lower bound sit at 5.25% for the balance of 2023. Regardless of the path of increases, Fed committee members believe at least three-quarters of a point further increases are necessary next year. 

Inflation projections were raised for the next several years. Members are concerned that inflation may become entrenched in consumers’ minds. This is easy to understand with food costs roughly 17% higher over this time last year. Eggs above $6 per dozen gets one’s attention. Outside of weaker demand for gasoline and used cars, every category of the “official” consumer price index is still rising. Health care insurance increases will hit February’s report, housing price drops will not hit until May at the earliest. Regardless, the Fed projects that inflation will drift down to 3.1% by the end of next year. 

Chairman Powell’s more important statement in his press conference was that the Fed will “stay the course until the job is done.” In other words, the Fed will not stop until inflation is back to near 2%. Their desire to break inflation and slow price increases to 2% should create doubt in markets that the Fed will stop around 5.25%. We believe the peak rate could be above 5.5% next year and stay at that level for longer than markets expect. 

Reaction

Treasury yields most recently peaked in October. Ten-year Treasurys closed at 4.24% and thirty years at 4.37%. Since then, yields have fallen almost in a straight line to today’s levels of 3.49% and 3.53%. At best, bonds are signaling that future growth will be muted. If a lower growth or mild recession path is in the cards, then what else would weigh on traders’ minds? One fact is that $9 trillion of the approximately $24 trillion federal debt matures in the next two years. That $9 trillion will have to roll over into new bonds paying interest in the 5% range, an almost three times jump from their current rates. Interest payments will increase from 8% to at least 12% of the discretionary federal budget over that time. Higher interest payments will cut into spending for everything but Social Security and Medicare. 

Stock markets have repeatedly hoped that the Fed would stop sooner and raise less. Those hopes have been repeatedly dashed. War pressures, union wage increases and decent monthly job growth are telling the Fed that the economy is, at worst, okay. An okay economy must slow further to crimp demand and reduce upward pressure on prices. That means lower earnings and ultimately lower stock prices. At this writing, stocks are slightly lower. 

Summary

Twelve more central banks have rate decision meetings between now and Christmas. Tomorrow the U.K.’s Bank of England and the European Central Bank will issue statements. Most are struggling to raise rates as fast as the U.S. this year. Across the globe, the path for short-term rates is higher. 

We think a mix of one-half and one-quarter of a percent increases is on tap for the next several Fed meetings. The peak or “terminal” rate for this rate increase cycle is likely closer to 5.5% than the futures markets’ 4.86% next May. We do agree with the futures markets that rate cuts by the Fed could occur as soon as early 2024. 

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Steve Orr is the Executive Vice President 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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