Fed leaves rates unchanged but with hawkish dot plot

The Federal Reserve left the Federal Funds target rate unchanged at 5.5% on its upper bound at the September FOMC meeting. The statement accompanying the FOMC decision upgraded its language on the US economy, saying it was expanding at a “solid pace” compared with “moderate pace” at the July FOMC statement. The September FOMC was also accompanied by new economic projections where the Fed upgraded its GDP forecast for 2023 to 2.1% from 1% previously and upgraded its outlook for 2024 to 1.5% from 1.1% in June. Unemployment for 2023 was also revised lower to 3.8% at the end of the year and the 2024 forecast was also revised lower to 4.1% from 4.5%.

The Fed’s projection of PCE core inflation was revised lower to 3.7% for 2023, down from 3.9% previously, but left it unchanged at 2.6% for 2024. Slower inflation with lower unemployment and faster GDP growth all suggest the Fed is thinking a “soft landing” is a baseline expectation for the US economy though Fed chair Jerome Powell explicitly said in the post FOMC press conference that it was not the Fed’s baseline assumption. 

The dots plot from the FOMC continues to imply one additional rate hike for 2023 that would take the Fed Fund up to 5.75% on its upper bound. FOMC members also firmed up their call for that additional hike with 12 members expecting it with 7 members seeing rates unchanged by the end of the year. Removing the additional hike may have been taken as a message that the Fed had declared victory on inflation and we think it speaks to the Fed maintaining a hawkish bias in its commentary and rates projections. Indeed, the dots for 2024 was revised higher by 50bps with the median rate projection at 5.1%, up from 4.6% previously. That would suggest just 50bps of rate cuts next year.

The growth projections for 2024 are only modestly below the longer run expectation of GDP growth of 1.8% estimated by the Fed. With a myriad of risks to growth on the horizon—a potential US government shutdown, student loan repayments restarting, disruptions in auto production caused by the UAW strike, higher energy costs—the growth assumptions appear aspirational and moreover don’t appear to generate an inflation response next year. With a lower inflation profile and higher median rate expectations, real rates in the US will be even more restrictive than they currently are and our assumptions predict, which could add another downward force on the economy. 

At this stage we retain our view that rates have peaked, with the current rate held through the next several quarters before three cuts of 25bps each between June and December 2024.