No pivot yet from the Fed

The Federal Reserve hiked the Fed Funds rate by 75bps at its latest FOMC meeting, taking the policy rate in the US to 4% on the upper bound. The vote for a fourth consecutive 75bps hike was unanimous among Fed policymakers with the statement justifying the hike changing little apart from a new line acknowledging that monetary policy operates with a lag and that the FOMC would take account of the “cumulative tightening” it has carried out this year.

In the press conference that followed, Fed chair Jerome Powell pushed back against the initial market assessment that the Fed was preparing to adjust policy. Powell said that the Fed still had “some ways to go” in its fight against inflation and that markets will need to prepare themselves for rates to move and stay higher than they had been expecting earlier this year. Powell did also note that the Fed could slow down the pace of tightening, perhaps as early as the next FOMC meeting in December though rates would still be moving higher.

Market reaction to the FOMC statement was initially very positive with currency, bond and equity markets rallying sharply. However, as it became clear that Powell remains adamant that policy will need to be “sufficiently restrictive”, markets sold off with 2yr UST yields spiking nearly 20bps from low to high and are edging higher today at around 4.6%. Markets are now pricing in a peak in the Fed Funds rate of more than 5% by the middle of 2023 and holding there until well into Q4 next year.

Markets had seemingly been hoping that the Fed would pivot into a more accommodative stance in the run up to the meeting despite the bounty of US data that the Fed would point to as justifying tightening. Earlier this week the US released another strong job opening print and the nonfarm payrolls report for October—due at the end of this week—is likely to still be robust, if slower. The Fed has shown this year that the performance of equity or credit portfolios is not its barometer for whether its policy is meeting its mandates of price stability and maximum employment. Moreover, a ‘pivot’ doesn’t mean that the Fed will immediately move to cutting rates or adopt a loose monetary policy stance. We expect there will be different thresholds the Fed will gauge before it decides to slow the pace of tightening, hold policy rates unchanged and then move to cutting only when it is clear the economy needs stimulus.

Fed chair Powell did say he didn’t think “inflation coming down decisively” was the “appropriate test” for slowing the pace of hikes which would seem to give the Fed room to shift to a 50bps hike in December even if inflation pressures don’t improve, particularly in the stickier core and services components of the CPI. Our expectation going into the meeting was for 75bps in November and 50bps in December before some further tightening pencilled in for 2023. The outlook for 2023 looks more inked in now, however, and we would highlight the risks for US dollar rates in the next six months are on the upside.