Macro views
Macro views

February FOMC meeting: The finish line is in sight

Market response

February 1, 2023 | 3 min read
Seema Shah
Chief Global Strategist

The Federal Reserve (Fed) stepped down their pace of rate hikes to a more familiar 25 basis points (bps) today, taking the benchmark rate up to 4.5%- 4.75%. Yet, as Fed Chair Jerome Powell noted many times during the press conference, “ongoing increases will be appropriate,” signalling that policy rates are likely to rise to 5.25% within a few months (in line with our own forecasted peak Fed funds rate). Powell also commented that if the economy performs as expected, the Fed doesn’t see rate cuts in 2023.

Overall, however, this was a Fed that believes its job is almost done, is pleased (albeit cautious) with the inflation progress to date, and doesn’t feel a strong need to push back against the recent loosening in financial conditions.

Inflation is trending in the right direction

Inflation data has been surprising to the downside of late, showing that the Fed’s 450 bps of hikes in the past year is finally starting to pay off. Chair Powell acknowledged this improvement, but also cautioned that inflation is still too elevated and that most of the progress has been limited to core goods inflation—accounting for just 25% of core inflation. He also reiterated that the inflation improvement was not grounds for complacency, and they (the Fed) need substantially more evidence to feel confident that inflation is on a downward path.

“Gratifying” labor market data

In addition to improving inflation, Powell sounded guardedly optimistic about the labor market. He noted that it has been “gratifying” to continue to see such strong jobs data even as wage pressures have started to abate. Certainly, financial markets over the past month have embraced this development and will be encouraged by Powell’s apparent hopes that a soft landing is achievable.

Financial conditions are loosening... in the near-term

With inflation starting to decelerate and the labor market also reporting positive news, most measures of financial conditions have loosened meaningfully—partially unwinding the impact of monetary tightening. While many investors had expected Powell to use the press conference as an opportunity to push back at the recent loosening, he instead appeared to be unconcerned about it, noting that he is more focused on long-term trends for financial conditions, which do, in fact, show tightening.

Recall that the latest dot plot, released in December, showed no rate cuts for 2023, and during recent speeches, Fed speakers have been emphasizing the “higher for longer” narrative. However, recent market pricing is inferring Fed rate cuts later this year. When asked about the dichotomy Powell said that market expectations simply reflect the fact that markets are anticipating inflation to come down more quickly than he expects. He even went so far as to say that, although he doesn’t expect rate cuts this year, “if inflation comes down much faster... it will be incorporated into our thinking about policy.”

In fact, the only point where Powell displayed any hawkishness was when he pointed out that, while they have no desire to overtighten rates, the risks of tightening policy too much were less than the risks of tightening too little.

Bottom line

While Powell may have started the press conference trying to deliver a hawkish message, his messaging appeared to become progressively more dovish. The overriding takeaway from the press conference today will be that this is a Fed that is approaching the end of the tightening cycle. Inflation is finally on the right path and, while they don’t have sufficient evidence to be fully confident, they have seen enough to be optimistic about the inflation outlook. From here on, the Fed’s policy decisions will be wholly data dependent—inflation and labor market data will be key to the path of the Fed funds rate.

Disclosure

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Views and opinions expressed are accurate as of the date of this communication and are subject to change without notice. This material may contain ‘forward-looking’ information that is not purely historical in nature and may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information in the article should not be construed as investment advice or a recommendation for the purchase or sale of any security. The general information it contains does not take account of any investor’s investment objectives, particular needs, or financial situation.

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