NewsyList

FED meeting: soft landing path narrowed

  • The Federal Reserve (Fed) hikes the fed funds rate by unanimous vote by 0.75 percent to 2.25-2.50 percent, in line with expectations.
  • She reiterated that quantitative tightening would continue with maturities up to $30 billion at UST and $17.5 billion at MBS, but increased to $60 billion and $35 billion in September.
  • The accompanying statement acknowledged signs of a slowdown in economic activity, but remained broadly unchanged compared with June, and reiterated that the committee was paying “close attention” to inflationary risks.
  • Chairman Powell indicated that rate forecasts presented in June are still relevant, ie hikes to 3.25/3.50 percent this year and another 50 basis points (bps) next.
  • He was repeatedly asked about recessions, which the Fed tries to avoid, but does not rule out.

As expected, the Fed tightened its monetary policy today. Fed Chair Powell has hinted that it “could” hike rates again by 0.75 percent in September. However, when asked about a US recession, the Fed Chair replied that the US is not currently in one, but steadfastly refused to rule it out in the future. Powell continued to stress the need to restore price stability, but we believe the Fed will do so with lower rate hikes than today in the coming months.

At today’s meeting, the Federal Reserve increased the fed funds rate by 0.75 percent to 2.25-2.5 percent. This was in line with ours and the broader market consensus, despite some initial market speculation that the Fed would follow the Bank of Canada’s move earlier in the month and hike by 100bps. The Fed raised the rate on excess reserves by the same 0.75 percent (to 2.4 percent). It also stated that it would continue to allow government bonds and mortgage-backed securities to mature, up to a limit of $30 billion and $17.5 billion, respectively. This time it was specifically reiterated that that pace will be increased to $60bn and $35bn respectively in early September as announced in May. He also added that given that the Fed is not largely in neutral territory, it would make sense to slow the pace at some point in the future.

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No update to the medium-term projections was made at yesterday’s meeting. The Fed’s accompanying statement was also essentially unchanged. The opening statement acknowledged signs of a slowdown in the economy and noted that “recent indicators of spending and output have weakened.” That marks quite a change from last month, which said overall economic activity was picking up too seems to have…”. The Fed reiterated that it is “monitoring inflation risks very closely” and “is committed to bringing inflation back to its 2% target.” On the surface, the Fed’s stance is little changed from June.

Although the Fed’s accompanying statement changed little, that seemed to be the tone that Fed Chair Powell was trying to strike at the press conference. Powell continued to point to the June dot-plot projections, which he called the key guide, with a rise to 3.25 percent or 3.50 percent by year-end and another 50 bp next year, calling it moderately hawkish . He reiterated that the Fed believes further rate hikes are appropriate and hinted that the Fed “could repeat” the unusually high rate hikes of the last two meetings in September that this is not yet a decision and he does not give any further information, but that the Fed is dependent on the data. He also added that given that the Fed is not largely in neutral territory, it would make sense to slow the pace at some point in the future.

The Fed chair has been repeatedly asked about the prospects for a recession. Powell spent much of the conference taking the words out of people’s mouths. He came to the conclusion that the USA currently probably not in a recession, especially given the strength of the job market. He also expressed doubts about gross domestic product (GDP) figures, which will be interesting in light of today’s release. Though Powell reiterated that a “soft landing” was the goal, he steadfastly refused to rule out the prospect of a recession and no longer spoke only of “some pain”. He even acknowledged that the path to a soft landing narrowed. Rather, the Fed chairman focused on the need for price stability to fulfill the full employment mandate over the long term. He also noted that those who are genuinely certain of a recession or a soft landing underestimate the magnitude of uncertainty.

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Ahead of this meeting, we assumed the Fed was broadly comfortable with current financial conditions, but would be difficult to maintain at this level. We assumed that the Fed would rather see further tightening than softening for the time being. This explained to us the ‘sameness’ of June’s approach, both on rate moves, statement and longer-term rate forecasts, as well as the Fed’s now unanimous stance and suggestion that it ‘could’ go back to 75bps in September. However, the economy is showing signs of a rapid slowdown; there are signs of easing in the labor market – if only in part, as Powell acknowledged; and talk of a recession is increasing. And we felt that Powell’s press conference was a little less fiery and hawkish than it was in June. For now, however, we maintain our view that the Fed will moderate the pace of rate hikes in the coming meetings to 50bp in September and 25bp in October, leaving rates unchanged at 3.25% in December. Should the Fed prove more nimble in slowing the pace of rate hikes, we think it will keep rates at that level for most of 2023.

Financial markets seemed to come to similar conclusions. Prices for the year-end fed funds rate fell 10bp to 3.29% from 3.39% before the meeting, the two-year yield fell 7bp to 2.98%, the dollar fell 0 on a DXY basis .7 percent, and the S&P rose 1.6 percent, topping 4,000 for the first time since last June’s Fed meeting. Interestingly, the 10-year yield, which has been falling amid growing growth concerns with shorter maturities, has fallen after the inversion fell, initially fell to 2.72 percent, but then rose again to 2.78 percent. Overall, financial conditions have eased, suggesting that monetary tightening will be less than feared. However, that may not be a conclusion the Fed is willing to concede to markets.

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