- As widely expected, the Fed hiked 25bps at the policy meeting on Wednesday.
- The meeting provided limited new information on the policy path or the Fed’s economic views.
- The Fed remains focused on core services ex-shelter inflation, which it does not think has turned yet.
- Markets remain far apart from the Fed on inflation and the FFR.
- They now see the Fed as more dovish than the ECB and BoJ, which is driving the dollar and the belly of the curve lower.
Powell Sticks to the December SEP
The Fed hiked the federal funds rate (FFR) by 25bps to 4.5-4.75% at Wednesday’s policy meeting. Widely expected, the downshift follows a 50bp hike in December and four 75bp hikes before that. The market read the deceleration as good news, with the S&P 500 closing over 1% higher and two-year yields dropping.
As I expected, Chair Jerome Powell provided limited new information on the Fed’s next moves. He confirmed that a ‘couple more’ increases in the federal funds fate (FFR) were coming. He further specified that if the economy proceeded as the Fed expects, as in the December Summary of Economic Projections (SEP), there would be no cause for rate cuts in 2022.
Powell did not answer questions on when the Fed might pause. Rather, he indicated that the FOMC macroeconomic forecast would be updated through the SEP at the March meeting.
He stressed that more data was needed to be confident that inflation was on a sustainable downward path but avoided providing a timeframe.
Powell acknowledged the progress on core goods inflation and said there was good cause to expect shelter inflation to moderate. However, he stressed that non-shelter core services inflation had yet to turn (Chart 1). The latter would likely require an easing of the labour market.
He added that the economic costs of tightening too little were higher than the economic costs of tightening too much because the latter could be more easily be addressed through policy changes.
As we expected, Powell did not get market pricing nearer the December SEP’s end-2023 FFR at 5.1%. Instead, markets reacted to the presser by shaving about 4bp from the June 2023 FFR and 10bp from the December 2023 FFR. The end-2023 FFR priced by the market remains about 70bp below the Fed.
The market is trading on the assumption that the Fed is close to pausing.
It is now treating the Fed as dovish relative to ECB and BOJ outlook, driving the dollar lower. And the lower dollar is pushing the belly of yield curve, especially the TIPs, lower.
This is bullish for US risk assets such MBS, high grade credit and equities.