•    Fed Funds overnight range increases 0.25% to 4.5% – 4.75%
•    “Ongoing increases in the target range will be appropriate” — the Fed is not done
•    Inflation remains “elevated” and job gains “robust”
•    Balance sheet reduction continues — over $1 trillion in 2023

On plan…

Following market expectations, the FOMC raised the overnight Fed Funds target by one quarter of a percent today. The increase follows the Fed’s forecasts and communications that the rate of increases would slow this year. Starting last March, this rate increase cycle stepped from one-quarter percent, then one half, and peaked at four increases of three quarters of a point each. December’s one-half of a percent and today’s one-quarter represent a downshift in the rate of increases, but not in the duration. The unanimous vote supported the Committee’s view that they are “strongly committed to returning inflation to its 2 percent objective.” Chairman Powell emphasized in his press conference that monetary policy will remain “restrictive” — in other words, rates will stay higher than Wall Street wants. 

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 will be smaller, but they did not stop at one more increase as speculated by many commentators. 

The Committee removed the “data dependent” language. It was replaced with “continue to monitor the implication of incoming information.” This phrase gives the Fed elbow room to pause increases to gauge policy impact. It also gives the Fed cover to 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.” 

Reaction

Treasury yields most recently peaked in October. Ten-year Treasurys closed at 4.24% and thirty-year at 4.37%. Since then, yields have fallen to 3.42% and 3.55%. At best, bonds are signaling that future growth will be muted. The ten-year yield has returned to its year-long uptrend. Thirty-year bonds have broken below their uptrend and are reflecting market positioning for long-term lower growth and inflation.

Stock indices are generally higher at this writing, sensing that Powell’s press conference is less hawkish on financial conditions and the level of the stock market than traders feared. 

Be aware that year-over-year consumer price comparisons will be lower in the spring. The CPI headlines will encourage Wall Street commentators to urge the Fed to stop increasing or reduce short-term rates. The Fed is determined to get inflation down and not worried about impacts on the economy. The core inflation numbers they watch continue to rise. 

Summary

Persistent inflation, a large portion of the U.S Treasury’s debt coming due and the Fed no longer buying bonds could pressure interest rates higher in the coming months. The counterargument is that a looming recession would push rates lower. In advance of a recession, the Fed and other central banks will continue to fight inflation by raising short-term interest rates. 

We think the path of short-term rates is higher, peaking above 5% later this year. 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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