By Olumide Owolabi
At its September meeting, a hawkish Federal Reserve conveyed its resolve to bring inflation down.
In another anticipated Federal Reserve meeting, the Federal Open Market Committee managed to surprise the markets, which were already aggressively pricing policy-path expectations.
The Fed’s adjustment of its policy rate, economic projections and “dot plot” signaled a firm message from a Committee that has finally come to terms with the reality that the labor market must be significantly weaker for the inflation battle to be won.
The Committee unanimously raised its policy rate by 75 basis points (the third consecutive 75bps hike), shifting the fed funds rate range to 3.00-3.25%. It also adjusted previous economic forecasts, with GDP growth revised down for 2022 and 2023 to 0.2% and 1.2%, respectively, while the anticipated unemployment rate was marked up to 4.4% by 2023 and the expectation for core PCE inflation was increased to 3.1% for 4Q 2023, 40bps higher than the June estimates.
In our view, the most important adjustment was to the “dot-plot” estimates of future policy rates, which projected a fed funds rate at 4.25-4.50% by year-end, 4.50-4.75% by 2023, 3.75-4.00% by 2024, 2.75-3.00% by 2025 and a long run rate of 2.50%.
The totality of the changes seems to imply a narrower path to a soft landing, while projecting a more restrictive path. The takeaway from the “dot plot” was the signal that the committee is expecting to remain firmly in restrictive territory above 3.00% for an extended period up to 2024 - subtly messaging the “Volker playbook” referenced at the Jackson Hole symposium.
At the press conference, in what is gradually becoming the norm - a failure to clearly deliver the committee's strong statement - Chairman Jerome Powell presented somewhat mildly dovish forward guidance for the next two meetings by stating that the door is open for a cumulative 100bp adjustment relative to the 125bps projected by the “dot plot,” while he once again emphasized data dependence. However, Powell avoided major dovish tilts by dropping previous language that 75bp rate hikes are unusually large.
Overall, this is a major shift from a Committee that was previously seeking an aggressive inflation response without acknowledging a material probability of a hard landing for growth and labor.
As such, we are adjusting our fed funds rate outlook accordingly. We now expect the rate to settle higher - around 4.50-5.00% by the first half of next year - with a symmetric tail risk on both sides dependent on the inflation trajectory and the speed of transmission of hawkish policy to the labor market.
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