Fed Hikes 0.75% - As Expected

Fed raises interest rates by 0.75%, bringing the Fed Funds Rate range to 2.25-2.50%. The FOMC is projecting 4 additional hikes this year, taking the year-end range to 3.25-3.50%. The market is aligned with the Fed, pricing in a year-end range of 3.25%-3.50%.

At its meeting today the FOMC voted unanimously to raise the Federal Funds rate to 2.25-2.50% and to continue its quantitative tightening plan.

For the first time in 2022, the statement mentioned softening spending and production data, an acknowledgement that recent economic data has been weaker.

The statement noted that, nevertheless, job gains remained strong and that additional hikes will likely be appropriate to curb inflation.

NOTE: An advanced reading of second quarter GDP growth is due out tomorrow morning.  The first quarter reading was -1.6%.  A negative print tomorrow will trigger headlines declaring a recession as many maintain that two consecutive quarters of real GDP declines constitute a recession.  That is neither the official definition of a recession nor the way economists evaluate the state of the business cycle.  The official definition is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”  In light of labor market strength and aggregate demand, we would generally align with Chair Powell’s view that it is difficult to characterize current economic conditions as recessionary.

Messaging at the press conference:

At the press conference, Chair Powell noted that bringing inflation down is necessary to have a period of sustained labor market strength.

Again, for the first time in 2022, Powell noted some softening in the economic data, noting consumer spending and production weakness. He attributed slower spending to lower real incomes as a result of high inflation.

The FOMC views aggregate demand to be strong, and demand for labor to be strong. Aggregate supply and labor supply remain challenged.

Powell said another ‘unusually large’ hike may be appropriate at the next meeting, depending on the data that comes in between meetings.

For the first time, Powell emphasized that returning inflation to the Fed’s 2% target may involve a period of slower economic growth (i.e. recession) and weaker labor markets (i.e. higher unemployment).

In Q&A Powell noted that the current rate, 2.25-2.50%, is in the range of what the Fed considers a ‘neutral’ policy rate. He noted a need to get the policy rate to ‘moderately restrictive’ territory and referenced the June meeting’s SEP where the fed projected a 2022 year-end rate of 3.25-3.50% and a 2023 year-end rate of 3.75-4.00%.

Market reaction:
The market opened higher today, led by tech stocks. Stocks held their gains and then rallied during the press conference.

Bond yields were mostly stable today. The 10 year drifted slightly lower throughout the morning and then fell further during the press conference.
The dollar weakened during the press conference. Gold rallied during the conference. Oil is up a couple percent.

Our takeaways:
The market priced in today’s hikes and seemed to interpret Powell’s comments as dovish. Stocks and bonds both rallied. The dollar fell. Gold rallied. All of these moves are consistent with a dovish interpretation.

In addition, for the rest of the year, the bond market has priced in the same types of hikes that Powell described as likely. So, the bearish bond market surprises may be behind us in the short-term.

We expect the Fed to be highly attuned to the path of inflation and for additional hikes to be forthcoming.

Powell noted several times that returning inflation to its target may require inducing weaker labor market conditions. That means the Fed may continue hiking even if we see some deterioration in unemployment if it does not coincide with slowing inflation.