FOMC: The (Perceived) Start of a Trend

BOSTON, MA, December 14, 2022 — The Federal Open Market Committee (FOMC) met today for the last time in 2022 to evaluate the state of the U.S. economy and monetary policy.

What We Learned

The FOMC raised the Federal Funds Target Rate (fed funds) by 50 basis points (bps), a well telegraphed downshift from the previous four consecutive 75 bps hikes, with the target band now at 4.25-4.50%. Markets largely anticipated the move, viewing it as the start of an eventual shift to even smaller future hikes and subsequent pause. With the two most recent releases of inflation data being lower than expected, market participants lean in the direction of a more sanguine inflationary and rate environment.

– The market now reflects a high probability of a 25 bps fed funds increase at the first FOMC meeting in 2023 (February 1).

– The market currently anticipates a peak fed funds rate around 4.90% in early 2023 and then a quick reversal with fed funds at 4.25-4.50% by year end.

– The Fed continues to normalize its balance sheet via Quantitative Tightening (QT) at the previously stated maximum monthly cap of $60 billion of U.S. Treasury securities and $35 billion of agency mortgage-backed securities. QT reduces excess money supply and excess market liquidity.

The Committee continues to anticipate that “ongoing increases” in the fed funds rate will be appropriate. To maintain policy optionality and flexibility, the statement notes that the Committee “will consider the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Chair Powell emphasized the need for further hikes at the press conference.  Even though the Committee is seeing improvement in goods inflation, housing inflation (i.e., rent) and non-housing related inflation (i.e., labor) remain elevated and require attention. Thus, the terminal rate of the fed funds rate and how long the Committee maintains that terminal rate are the two important questions that remain unanswered and subject to incoming economic data and financial conditions.

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