Fed Delivers a Dovish Pause – References Tighter Financial Conditions

  • As widely expected, the Fed kept the funds rate unchanged a 5.25% – 5.50%. Also, the statement was largely unchanged from September except for characterizing economic activity as “strong” vs. “solid”. The statement also added a mention to tightened financial conditions, recognizing the increase in longer-term yields over the past few months.
  •  Since this was not a quarter-end meeting there were no updated economic or rate forecasts. The only information coming from the meeting is the attached statement and the post-meeting press conference where Powell will add more color to today’s decision.
  • Futures pricing prior to the announcement had the median terminal rate of 5.41% with 80bps of rate cuts by year-end 2024. Those futures levels continue to be mostly held in early post-meeting trading. In the Fed’s September forecast, they had one more rate hike this year with 50bps in rate cuts beginning in 2024 with the median rate at 5.125% by the year-end 2024. There is, however, a wide range within the committee where 2024 ends with a high of 6.125% and a low of 4.375%.
  • In the September forecast, the Fed saw core PCE ending 2023 at 3.7% then dropping to 2.6% in 2024. It currently stands at 3.7%. This could be used as a rationale to stand pat through year-end, especially if inflation continues to show improvement and employment gains slow.
  • In summary, the Fed delivered an as expected rate decision with a recognition of tighter financial conditions due to increased yields, especially on longer term maturities.  With two additional inflation and employment reports due before the December 13th FOMC meeting the Fed will get plenty of data to justify a hike or no hike decision.
  • We think the bar to another rate hike is quite high such that inflation and/or employment growth will have to show upside surprises.  While the market has more rate cuts in 2024 than the Fed is projecting, we could start to see the Fed pushing back on that more, especially if the economy fails to show signs of weakening. However, given the ISM Manufacturing miss this morning that weakness could be starting to reveal itself. It will take more than one report to shift the Fed’s outlook, but it does warrant close attention to upcoming economic releases.

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Published: 11/02/23 Author: Thomas R. Fitzgerald