The Fed Raised Rates as Expected but Gave Us Nothing on What’s Next

Eleventh Hike & Uncertain Outlook

After ten consecutive hikes since the March 2022 lift-off, policymakers paused the rate hiking cycle last month, in order to assess incoming data and the impact of their actions thus far. After that brief reprieve, the Fed raised rates by 25 basis points on Wednesday, to 5.25-5.5% and the highest level since 2001. ^[1]

The move was totally priced-in by markets, so attention turned to what the bank would signal for the future path of monetary policy. However, Chair Powell offered us nothing on that front, as he refused to commit to the next steps, making this the most certain and uncertain decision of the year.

On the one hand, he stressed the need for a sustained restrictive monetary stance and kept the door open to further tightening, stressing that "we need to be prepared to raise further". On the other hand, he touted data dependence and warned that a hold is "possible" in September. ^[2]

Inflation has been coming down fast, with headline CPI decelerating to 3% y/y in June and the stickier core also moderating notably to 4.8% y/y. The central bank has delivered 525 basis points worth of hikes in a short period of time. Given the lagging nature of tightening, there is a good chance that it has already done enough to lower inflation to the 2% target.

However, the Fed has been burnt before and it would be premature to declare victory now,with Chair Powell downplaying the the last soft CPI report as "just one reading". What's more, the labor market remains "very tight", with unemployment close to five-decade lows and the economy performing better than expected. This makes it hard for policymakers to back down, as achieving the inflation goal without an economic slowdown and a hit to the job market, would defy the Phillips Curve and validate the immaculate disinflation scenario.

The Fed's own projections for a median terminal rate of 5.6% ^[3], imply an additional 25 bps increase this year, but markets have never embraced that. They view yesterday's move as the last of the cycle and expect rate cuts in the first quarter of 2024, according to CME's FedWatch Tool ^[3]. However, such optimism has been disappointed before.

Yesterday's decision did not make us any wiser around the policy outlook, as Chair Powell adopted an equivocal stance, keeping all options on the table. With more than a month until the next meeting, policy makers will have a lot of data to assess before they make their decision. This sets us up for an uncertain autumn.