FOMC signals hiking not finished, only slowing down

The FOMC raised the fed funds target range by 50bps at its meeting yesterday, taking the upper bound to 4.50%. This was in line with our long-held expectations, and the consensus outlook was also for a slowdown from the straight run of four 75bps hikes at the meetings prior to this one. The decision was a unanimous one.

Fed funds rate upper bound, %

Source: Bloomberg, Emirates NBD Research

The slowdown in the pace of rate hikes was made more likely on the back of the CPI print released the previous day. While PPI surprised to the upside last week, the latest CPI inflation rate fell to 7.1% in November, down from 7.7% in October. This was lower than the consensus forecast of 7.3% and marked the slowest pace of price growth since December last year. While this remains far higher than where the Fed would like it to be, inflation does appear to have peaked, giving the bank room to slow down.

CPI inflation, % y/y

Source: Bloomberg, Emirates NBD Research

With little surprise in the rate decision, the focus was on Jerome Powell’s press conference and the revised predictions from officials for the coming year. Powell was at pains to maintain a hawkish tone, and while he welcomed the likelihood that inflation has now peaked, he stressed that ‘we still have some ways to go’, repeating the language used at the November press conference. Powell said that rate cuts will not come until inflation is coming down in a sustained way towards its target level and that ‘that will be some time.’

Powell’s comments were supported by the revised ‘dot plot’ of FOMC member predictions for rates, which showed that there remained support for further tightening next year as the end-2023 rate rose from 4.6% to 5.1%, suggesting 75bps more of hikes yet to be implemented before coming down once more in 2024. Moreover, Jerome Powell warned that there remained a chance that officials’ estimate of the terminal rate would be moved upwards once again. In particular he highlighted the tightness of the labour market and the relatively high rate of wage growth, which at around 5% is inconsistent with an inflation target of 2%.

The higher terminal Fed Funds rate was justified by the upward revision to the Fed's inflation forecasts, with core PCE inflation next year now expected to reach 3.5% in Q4 up from 3.1% previously, before falling to 2.5% by late 2024 (2.3% previously). The Fed downgraded their growth forecast next year to just 0.5% next year, from 1.2% forecast in September, and revised up their forecast of the unemployment rate to 4.6% from 4.4% previously on the back of higher projected interest rates. Such an increase in the unemployment rate (from the current 3.7%) has historically only happened during economic recessions.

Market expectations for Fed hikes

Source: Bloomberg, Emirates NBD Research

The market remains more dovish on the rate outlook, with traders pricing in a peak Fed Funds rate of 5.0% in H1 2023 followed by two rate cuts in H2 taking the benchmark back to 4.5% by the end of next year.

The language and revised projections make clear that the pivot is not here yet, even if traders are not quite taking the Fed at its word with regards the outlook for next year. The commentary from officials in the coming days and weeks will be key to watch but the unanimous decision and the spread of the dot plot suggests a relative consensus amongst FOMC members around the need for still tight policy. The Fed will likely move to cutting when inflation has slowed substantially and the economy starts to look in need of some stimulus, but to date macroeconomic indicators have held up well in the face of this hiking cycle, with the labour market in particular still performing strongly, and so the focus will remain firmly on inflation.