Key Takeaways from FOMC Decision

What happened?

The FOMC met and decided to hike rates by 75 basis points.

It also released its quarterly ‘dot plot’, showing a policy prescription that is more hawkish than expected, and much higher than its June ‘dot plot’:

• Median fed funds rate at end of 2022 is 4.4%, up from 3.4% in June. Median expected terminal rate of 4.6% versus 3.8% expected in June.¹
• Growth is expected to be lower than expected in June: The median estimate of GDP growth is now only 0.2% in the year to 2022 Q4 (previously 1.7%) and 1.2% to 2023 Q4 (1.7%).¹
• Unemployment projected to be higher than was expected in June: with unemployment expected to rise to 4.4% (vs 3.9%) in 2023 Q4, from 3.8% (vs 3.7%) in 2022 Q4.¹
• Inflation is expected to be higher than June’s projections: the median estimates of core PCE inflation at 4.5% (vs 4.3%) projected for the year to 2022 Q4, 3.1% (vs 2.7%) to 2023 Q4, 2.3% (vs 2.3%) to 2024 Q4 and 2.1% to 2025 Q4. Inflation is not expected to come back to target until end-2025.¹

In the press conference, Fed Chair Jay Powell characterized the Fed as taking “forceful and rapid steps to moderate demand” and that “there is still a way to go.” Powell acknowledged that longer-term inflation expectations remain well anchored, but that he would like to keep it that way through this aggressive path.

The Fed also announced that it will continue to follow its quantitative tightening plan, which means a substantial increase in the monthly amount of securities being rolled off the balance sheet.

In short, there was no Fed pivot today.

How have markets reacted?

US stocks fell, then rose, then fell again, with the S&P 500 finishing the day down 1.7%. The Dow also fell 1.7% today, while the NASDAQ was down 1.8%.²

The 2-year US Treasury yield finished higher at 4.04% and the 10-year US Treasury yield finished slightly higher at 3.531%. The 2s-10s spread widened to -53 basis points. The spread between the 3-month / 10-year US Treasury spread remained positive at 22 basis points.²

Copper fell while gold rose modestly today, reflecting dimming prospects for the economy as tightening continues aggressively.

What is our outlook on the situation?

The market reaction is to be expected, given the hawkishness of the ‘dot plot.’ If you were to compare this rate hike cycle to previous rate hike cycles going back to 1983, the Fed has never raised rates this much in this short a time period. It is becoming increasingly difficult for the US to avoid recession given the Fed’s “forceful and rapid” rate hikes.

More hawkish Fed rhetoric is likely going forward. And we are likely to see continued hawkishness from other major central banks such as the ECB, the Bank of England and the Bank of Canada.

What is our resulting investment view?

In the shorter term, risk assets are likely to underperform as the increased risk of recession is more fully discounted by markets. The Fed’s policy going forward will largely dictate how significant and long-lasting the US’ economic downturn is, and therefore how soon stocks will begin to discount a recovery.

Dollar strength is likely to continue in the shorter term given the hawkishness of the dot plot.

Taking a step back, we are witnessing the normalization of monetary policy and the normalization of markets, which should be positive. However, it is the speed and size of the rate hikes that is creating disruption for major asset classes in the near term.

What are the risks to our view?

The downside risk to our view is that the Fed comes to believe inflation is more entrenched and that it needs to become more aggressive – essentially a continuation of the playbook we have seen this year where the Fed has followed a slippery slope of increasingly aggressive policy as its views on inflation (supported by data) have changed.

The upside risk to our view is that the Fed proves to be less hawkish than markets now anticipate.