The Fed Embraced Soft Landing & Confirmed the Higher-for-Longer Mantra

Fed Hold

The US Federal Reserve held rates at 5.25%-5.50% unanimously on Wednesday ^[1], in the second pause of this tightening cycle, during which it has delivered 525 basis points worth of hike.

This massive amount of tightening since the March 2022 lift-off, has brought monetary police at a "restrictive level". Chair Powell said that given how far they've come, policymakers are in a position to "proceed carefully" and they are "fairly close" to where they need to be. ^[2]

The central bank has slowed the pace of tightening this year, as it comes closer to the end and inflation has moderated substantially, while employment conditions are coming into better balance and the economy has shown some signs of softening. This has allowed it to adopt a more laid-back stance and assess the evolution of incoming data.

More Tightening in Play

Despite the progress, inflation remains "elevated", the labor market is still tight and economic activity has been expanding at "a solid pace", maintaining pressure for further monetary restraint. The policy statement alluded to that, since it repeated the "in determining the extent of additional policy firming that may be appropriate…" passage.

Chair Powell clarified that Wednesday's hold does not mean policy is sufficiently restrictive, adding that officials need to see "more progress" before they can reach that conclusion. Furthermore, they maintained their 5.6% median terminal rate forecast, which suggests one more hike this year, with twelve participants still seeing rates above 5.5%. ^[3]

Higher for Longer

The updated Summary of Economic Projections (SEP) not only kept more tightening in play for this year, but also confirmed the higher-for-longer narrative. Participants lowered the 2024 median rate projection to 5.1%, from 4.6% prior, showing a tougher stance ahead and fewer cuts than previously thought. Nine members now view rates staying above 5% next year, from six in the previous dot-plot.

Source: https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20230920.pdf

Soft Landing

When asked during his press conference whether he would now call a soft landing the baseline expectation, Chair Powell succinctly stated "no, no, I would not do that". However he said this is a primary objective for the Fed and still a possible outcome, but more importantly the new SEP indicates that the Fed has embraced the soft landing scenario.

Participants more than doubled their 2023 GDP growth forecast to 2.1% and raised it for the two subsequent years as well. They also lowered the unemployment rate projections for those three years. Things were a bit more mixed on the inflation front, where changes were incremental, but both core and headline PCE are now seen falling to 2% in 2025.

Market Reaction

The USDOLLAR strengthened, while stock and bond markets fell after Wednesday's decision, as the Fed kept more hikes on the table and hinted at a tighter policy ahead. Markets still think the terminal rate has been reached, albeit with less conviction and the timing of rate cuts has been pushed back. CME's Fed WatchTool currently places the first hike in July of 2024 the earliest and assigns the highest probability to that year ending with rates at 4.75-5.00%. ^[4]