"We Will Stay the Course, Until the Job is Done"

December 15, 2022

Jim Palmer, CFA, Chief Investment Officer
Budapest, Hungary - 4 October, 2022: rope access technicians hanging on the side of a metal high-rise building and cleaning the facade
"We Will Stay the Course, Until the Job is Done"

Seems definitive to me. Give the man his due; Federal Reserve (Fed) Chairman Jerome Powell keeps saying inflation is “public enemy number one,” and the Fed is prepared to do too much rather than too little in the inflation fight. Financial markets just don’t want to listen.

At the November 2 meeting, Fed officials guided investors toward a slower pace of rate hikes given the cumulation of past rate hikes, a higher terminal rate relayed through the Fed Dot Plot and a longer period of higher rates. At the December 14 meeting, Fed officials delivered on the first two points and guided as best they could on the third. But investors are in a “prove-it” mode and continue to price in late-2023 rate cuts. This is the primary source of tension between the Fed’s outlook and investor expectations.

The November Consumer Price Index report, released on December 13, was lower than expected and reflected a meaningful fall in core goods prices. The yield curve plunged on hopes the report would give the Fed enough comfort to adopt a more dovish tone and signal a potential pause or even pivot on upcoming rates policy. No such luck. Investors remain undeterred and post-meeting fed futures continue to forecast two 25 basis point (bps) rate cuts by the end of 2023. For the record, we think the Fed will follow through on keeping rates at the terminal rate through next year and not pivot toward rate cuts.

In the near term, our outlook is for another 50 bps rate hike on February 1. We are of a mind the sooner the Fed reaches its terminal target rate the better, for both markets and the inflation fight. Also, once the Fed dials down to 25 bps, there is no going back. Markets just won’t accept it and the hit to Fed credibility would be counterproductive. The good news is, we are near the endgame for rate hikes and how we get to the terminal rate is increasingly less important than how long we stay there.

In the end, perhaps everyone over-complicates the Fed’s thought process and the bare bones argument may come down to; 1) Inflation measures are trending in the right direction but remain unacceptably high. 2) Labor markets are robust, with an unemployment rate of 3.7% – the 50-year low is 3.5%. 3) If you are not going to fight for 2% inflation when unemployment is 0.2% off a generational low, when would you?

Markets may not want to hear it, but Chairman Powell made it clear that is exactly what he plans to do.

Key points coming out of the December 13-14 Fed meeting and Chairman Powell’s press conference:

  • With a 12-0 vote, the fed funds target range was raised 50 bps to 4.25 to 4.50%.
  • The overnight reverse repo rate was raised to 4.30% and kept the per-counterparty cap at $160 billion.
  • The pace of balance sheet reduction remains at the $95 billion monthly cap.
  • The FOMC Dot Plot median forecast of the federal funds target range was raised to 5.00% - 5.25% (+50 bps from the September 21 Dot Plot) by the end of 2023. Seven of nineteen voting members expected a terminal rate of 5.40% or higher at some point in 2023.
  • For the February 1, 2023 meeting, late-day Wednesday fed funds futures reflected a 27% chance of a 50 bps rate hike and a 73% chance of 25 bps

Bloomberg Unemployment Rate, FOMC Dot Plot and CPI Index

FOMC Press Release, December 14, 2022

Transcript of Chair Powell's Press Conference Opening Statement, December 14, 2022