Fed Monitor: Passthrough Risks 

Summary of Key Issues  

Current Fed View 

The evolution of the SEP end-2023 inflation and unemployment forecasts shows the Fed is much more focused on the employment than inflation leg of its mandate (Chart 1).    

My base case is one more 2023 hike in November, based on inflation likely to track the SEP forecast, and three 2024 hikes starting around midyear based on inflation remaining around 4%. This compares with market pricing a 50% chance of a 2023 hike and three 2024 cuts (Chart 2).    

With slow growth in bank assets and therefore in reserves demand, QT is likely to continue into 2024 based on a continued decline in the RRP and stable reserves (Charts 4, 5 and 9). 

Tighter Financial Conditions but Fed Put Not in Play 

Over the past two months, financial conditions have tightened, though the FCI remains below the peak of Q4 2022 (Chart 7). The Fed has ignored the tightening and will likely keep doing so.  The tightening of financial conditions has not translated into financial instability: for instance, bank borrowing from the Fed and credit spreads are stable.   

In addition, inflation is still too high and growth above trend and possibly accelerating.   

Finally, Chair Powell has given up on jawboning short-term changes in financial conditions. 

Passthrough From Energy Prices to Core Inflation Key Issue 

Energy price inflation appears set to turn positive YoY, based on an undersupplied market and despite the current pullback which Viresh expects to be temporary. The risk for the Fed, given the very low unemployment rate and strong and accelerating growth, is that the high energy prices could pass through to core inflation (Chart 11). 

It will likely take a few months of data to get clear evidence on passthrough from energy (or the lack of it). Meanwhile, risk management suggests the Fed will stick to its current plan for an extra 2023 hike. 

Latest statement 

Latest minutes 

Current Fed Macroeconomic Forecast 

Markets Under-Pricing the Fed 

Economic Data Still 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.)