When Doves Try

As expected, the Fed raised rates by 50bps on Wednesday, capping a tumultuous year defined by the highest inflation in a generation and the most aggressive policy tightening in decades.

The half-point move snapped a four-meeting streak of 75bps increases and brought the total for 2022 to 425bps (figure below).

Wednesday’s decision came a day after inflation figures for November suggested price growth was cooler than expected for a second month, ostensibly giving Jerome Powell and his beleaguered colleagues plausible deniability for the well-telegraphed “step-down” to smaller hike increments.

“Tuesday’s inflation data was undoubtedly a welcome development for policymakers insofar as it dovetails well with the transition to a slower pace of rate increases,” BMO’s Ian Lyngen and Ben Jeffery said. “However, as the yearly gains in consumer prices continue to illustrate, there remains an uncomfortably high level of inflation in the US economy and the Fed has more work ahead in its effort to reestablish price stability.”

The new statement described inflation in familiar terms. Price growth “remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures,” the Committee said. That language was unchanged from November.

Although the moderation in goods inflation (and particularly core goods inflation) is likely to continue in 2023, the services sector remains a question mark. Wage growth remains extremely elevated amid stiff competition for scarce workers. At the same time, the fallout from the pandemic housing bonanza is still working its way through to the official inflation data — that process won’t be complete for months.

All derision, well-deserved and otherwise, aside, the Powell Fed can no longer be described as completely derelict. The global policy response — hopelessly late as it was in most locales — at least suggested central banks haven’t forgotten how to hike rates swiftly in the event aggressive action is warranted (simple figure below).

Most critics would’ve scoffed at the idea of 425bps of hikes in just 10 months from a post-Lehman Fed. The same critics would’ve harbored similar reservations about the notion that Powell’s colleagues across the developed world would’ve likewise deployed aggressive rate increases.

But it’s plainly not enough. Certainly not for critics, but not enough for the Fed either. Officials retained language tipping “ongoing increases in the target range,” which are judged to be “appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.”

The new dots reflected a Committee that would like to hold the policy rate just above 5% through 2023 once the peak is reached. Market pricing was around 5% prior to Tuesday’s inflation data, which prompted traders to temper their expectations for the terminal rate to around 4.85%. As a reminder, the September projections suggested peak Fed funds would be 4.6%. Seven officials see rates above 5.25% next year.

The spread between the 2023 and 2024 dots suggested modest easing (100bps) after a lengthy period spent holding at or near terminal. The market isn’t likely to buy into the notion that rate cuts aren’t at least possible in the back half of next year. The long-run dot was unchanged — again. That’s important: Core inflation is triple target, and “sticky” measures designed to capture the underlying trend remain very elevated. If we’re transitioning to a new macro regime (i.e., away from the vaunted Great Moderation), then policymakers will eventually be compelled to reassess the neutral rate.

The new economic projections were predictable. Officials nudged up their unemployment forecasts, but not by enough to pacify those who insist that anything less than 5% is unrealistic in the context of fighting inflation that’s triple target. The median 2023 and 2024 jobless rate projections moved up to 4.6% from 4.4% in September (figure below).

The growth outlook was upgraded for this year and cut by more than half for 2023. Of course, the Fed doesn’t see a deep recession — they never do.

Officials expect inflation to moderate and return to target by 2025. Both the headline and core PCE forecasts for 2024 were raised to 2.5%, suggesting officials expect to be cutting rates with inflation still a half-point above target. The median core projection for next year moved up to 3.5% from 3.1%, which was notable.

I’m not inclined to devote much in the way of analysis to the Committee’s economic projections. The growth and unemployment forecasts amount to the Fed meeting critics halfway. The near-term inflation projections are a mark-to-market exercise. The medium-term forecasts reflect what policymakers hope will happen. The long-term inflation outlook amounts to little more than an assertion that the macro regime hasn’t, in fact, shifted durably — that inflation was “transitory” after all, if you’re willing to swallow the notion that “transitory” means half a decade.

Besides the new policy rate, there was only one change to the statement language. The war in Ukraine was described as “contributing to upward pressure” on inflation as opposed to “creating additional upward pressure.”