Fed Monitor: November FOMC to Pause, Not Finish

Summary of Key Issues

Current Fed View

The Fed reaction to inflation surprises shows it is more focused on the employment than on the inflation leg of its mandate (Chart 1).

My base case is one more hike in December, based on inflation tracking the SEP forecast, and three hikes in 2024 starting around mid-year, based on core remaining around 4%. This compares with market pricing a 20% chance of a hike in 2023 and three cuts in 2024 (Chart 2).

With slow growth in bank assets and therefore in reserves demand, quantitative tightening will likely continue into 2024, based on a continued decline in the RRP and stable reserves (Charts 4 and 5).

Tighter Financial Conditions

Against rising inflation risks, long-term (LT) yields have been rising and financial conditions tightening since mid-2023 (Charts 6 and 7). This has led some FOMC members, starting with SF Fed President Daly in early October, to argue that fewer hikes are needed to stabilize inflation.  A FOMC consensus on a November pause has emerged, though for Chair Powell and Governor Waller, at this stage the pause is more to observe how the economy is adapting to higher yields than to end the tightening cycle altogether.

I expect the economy to prove resilient to higher yields, largely because those reflect higher growth and also because of Fed liquidity support to banks and implicit government guarantee of all bank deposits (Charts 8 and 9; see Maturity Wall Far, Far Away and Adieu QE, Hello Higher Yields).

Rising Inflation Risks

In the September SEP, 14 out of 19 participants saw inflation risks weighted to the upside. Since then, inflation risks have increased.

Q3 growth is expected well above trend (Chart 12). The November meeting minutes noted the persistent growth surprises, though they stated that ‘participants expected that growth would slow in the near term’.

Furthermore, energy price inflation is about to turn positive YoY. And there are already some signs of passthrough to core inflation (Charts 10 and 11). In view of the very low unemployment and strong growth, passthrough risks are considerable.

Inflation would have been higher were it not for the administration’s policy of increasing legal, employment-based immigration, which has contained wage growth.

In his latest speech, Chair Powell warned that ‘more signs of above-trend growth, or that tightness in the labor market is no longer easing, could warrant further tightening of monetary policy.’

My expectations are that, based on loose fiscal policy, poor transmission of monetary tightening, and low household savings rate, there will not be enough signs of slower growth by the December meeting to prevent a further FFR hike.

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Current Fed Macroeconomic Forecast

Recent FOMC Comments

Markets Under-Pricing the Fed

Economic Data Calls for More Fed Tightening

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)