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What You Should Know About the Latest Fed Action

What You Should Know About the Latest Fed Action

February 07, 2023
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What a Difference a Year Makes

A year ago, the federal funds rate was close to zero, consumer price inflation reached 7.9%, and yet the 10-year Treasury yield was 1.79%. What a difference a year makes. Inflation clearly had more upside and from this vantage point, the Federal Reserve (Fed) was late in pursuing price stability.

As expected, the Federal Open Market Committee (FOMC) raised target rates yesterday by just 0.25% to a range of 4.50%–4.75%. After raising rates at the fastest clip since the 1980s, today’s fed funds rate is the highest since 2007. The rapid rise in rates has indeed tamed inflation. After reaching a peak last year, inflation rates have clearly decelerated as tighter financial conditions and better supply chains have both reversed the inflation trend.

Fed Talks about Ongoing Increases

According to yesterday’s statement, the FOMC is comfortable accepting that inflation has eased, which is a micro-step toward a pause later this year. The FOMC statement reveals the Committee’s commitment to “ongoing increases in the target range” so the end of the hiking campaign will not likely happen until the second quarter. Investors should expect the Committee to raise rates at least one more time.

As shown in the chart below, the fed funds upper bound is higher than the latest reading on the core deflator, the first time since the beginning of the global pandemic. As inflation cools and the economy slows, the Committee’s approach to the dual mandate will evolve and that evolution has already started with this recent decision. When investors compare the current statement with last year’s, investors should conclude the days of any hikes greater than 25 basis points (0.25%) are over for this cycle. It seems the Committee no longer worries about the “pace” but is now focused on the “extent” of future increases.

View enlarged chart´╗┐

Conclusion

After the latest decision, the fed funds upper bound is higher than the latest reading on the core deflator. Inflation is poised to ease further in the coming months, which will give the Fed some leeway to end its rate hiking campaign. The FOMC will likely hike rates again by 0.25% on March 22, but the debate builds about potential decisions made on May 3 (our best guess at this point is the Fed pauses in May). And most importantly, investors should remember that history shows that markets respond favorably after the end of a rate hiking cycle.

 

IMPORTANT DISCLOSURES

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