The Federal Reserve Open Committee met last week and as expected announced plans to continue the current path of increasing the Federal Funds rate, but this time by a reduced .50 percent.
Hope Springs Eternal … But Should It?
“I think it’s a classic tale of hope springs eternal. We don’t think there should have been such optimism,” Alan McKnight, chief investment officer at Regions Bank told New York Times reporter Joe Rennison in a conversation following the meeting. “I think there was a hope that the Fed may have considered a slightly lower target for next year.”
According to the press release from the Federal Reserve, the Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/4 to 4-1/2 percent.
“Once the Fed reaches a normalized level of rates, we believe a pause in rate increases for an indefinite period is more likely than a pivot to monetary accommodation,” McKnight said. “The recent FOMC statement from November and press conference with Chairman Powell merely reinforced these beliefs.”
Pushing Hard or Hardly Pushing Back
Regions Chief Economist Richard Moody weighed in with his latest economic update December Fed Meeting: Pushing Back Hard, Or Hardly Pushing Back.
“Perhaps not significant, but nonetheless noteworthy is that one Committee member assesses the risk to their inflation forecast as being to the downside, the first such instance of this since the March 2021 projections,” noted Moody. “The Committee as a whole, however, continues to see the risks to their inflation forecast as being weighted to the upside despite the higher forecast. This goes to the point made by Chairman Powell at his press conference, which is that despite recent signs of progress, the FOMC is not close to being convinced inflation is on a one-way path lower.”
Moody noted that the updated dot plot implies a “higher for longer” course for the Fed funds rate than had been messaged in the September projections. In his report he shared that the updated economic projections include a meaningful downgrade in the forecast for 2023 real GDP growth, a higher unemployment rate, and higher rates of headline and core inflation.
“While the updated dot plot can be seen as consistent with the higher inflation forecast, it could also be part of an effort to push back on further easing in financial conditions and the perception held by many market participants that, wherever the terminal funds rate proves to be, rate cuts will be soon to follow. Whether that message is getting through remains an open question,” said Moody.
“Equities didn’t like what they heard, or more appropriately, saw out of the FOMC,” noted Brandon Thurber, Chief Market Strategist at Regions. “Selling off as the Committee’s Summary of Economic Projections, or dot plot, pointed toward a higher-than-expected terminal fed funds rate.”
Thurber continued with the takeaway that the median Committee member now expects fed funds to peak at around 5.1 percent in 2023, up from 4.5 percent when released in September 2022. A higher terminal fed funds rate will depress equity valuations and what investors are likely willing to pay for future earnings.
“Market participants have been banking on a Santa Claus rally out of stocks into a historically seasonally strong spot in the calendar, but the FOMC decision may generate a more muted or modest response from equities into year-end,” Thurber said. “I have long felt that the bond market was doing a better job than stocks were in interpreting the Fed’s intentions, and evidenced by the minimal change or shift in Treasury yields on the heels of the announcement and updated dot plot, we remain convicted in that view.”
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