FOMC Policy Announcement — Fed Ups the Tightening Ante

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Michael Gregory, CFA, Benjamin Reitzes 15 juin 2022 Recherche et stratégie

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EconoFACTS

The FOMC raised the fed funds rate by a beefy 75 bps to 1.625% (the midpoint of the 1.50%-to-1.75% target range). Such a hefty hike last happened in November 1994, marking only its second occurrence in the past 33 years. This was a big and bold policy move in response to a worsening inflation situation. The decision was not unanimous with Kansas City President George dissenting in favour of a 50 bp action.

Last month, Chair Powell proffered unprecedented forward guidance in stating 50 bp rate hikes at the next two meetings (today and July 27) were “on the table”. However, in the wake of recent reports (literally since Friday) showing accelerating monthly moves among an array of core inflation metrics (particularly the median and mean CPIs), along with increasing consumer inflation expectations (particularly over the next five years), even larger rate hikes were likely quickly pulled on the table too. Saving some of the Fed’s forward guidance credibility, it helped that the OIS market had quickly almost completely priced in back-to-back 75 bp actions for today and next month. These expectations were reinforced by some very timely and well-placed media reports (what a coincidence!).

So, where do we go from here? The ‘dot plot' in the Summary of Economic Projections (SEP) provided a powerful clue. All 18 participants had at least a 3.125% fed funds forecast for the end of this year. There was only one member of the ‘3-handle’ club in March’s SEP. Now everybody is in the same boat as St. Louis President Bullard who turns out to have been quite prescient. The median is now 3.375%, representing a further 175 bps of tightening from the current 1.625%. More rate hikes are projected next year by almost all participants; only one dot drops. The median is up another 37.5 bps to 3.75% (which means either 3.625% or 3.875%). There are five members of the new ‘4-handle’ club in 2023. The median reveals rate cuts in 2024, although they could be starting before the end of next year for some participants.

The more aggressive tightening path does take its economic toll. The median projection for real GDP growth this year and next was lowered to 1.7%, slightly below potential of 1.8%, and below the previous projections of 2.8% and 2.2%, respectively. The unemployment rate eventually rises above 4% (4.1%) by 2024, 0.5 ppts above the prior forecast. Meanwhile, inflation is projected to come under control quickly, back to about the mid-2% range by next year (2.6% total, 2.7% core) after ending this year at 5.2% for the total and 4.3% for the core. The former is up 0.9 ppts from before, with the latter up 0.2 ppts.

Bottom Line: America’s inflation problem has become broader and more persistent. In quick response the Fed intends to tighten more aggressively. Unfortunately, this also carries with it an escalating risk of precipitating a recession. Given a demonstrably more aggressive Fed, we've slightly upped the ante on our Fed call as well. Previously, we had policy rates peaking by the end of this year at 3.125%. We raised this by 25 bps to 3.375%; we switched July's move to 75 bps instead of 50 bps. We also end this year with a pair of 25 bp moves instead of a solo effort, reckoning that a greater sense of Fed caution will likely emerge as autumn unfolds with even more purchasing power erosion weighing on spending and even weaker financial conditions rippling through the economy. We don't see rate hikes continuing into next year at this point, unlike the Fed (and we peak below the FOMC's projection). But, we also expect that real GDP will grind to a near halt (averaging just 0.3% annualized) through the turn of the year.

From Benjamin Reitzes, our Canadian Rates & Macro Strategist...

We are also revising our expectations for the Bank of Canada's rate path. With a more aggressive Fed, the BoC having already warned it could act "more forcefully", and our expectations for a very strong May CPI report (out next week), we are now anticipating that the BoC will hike rates 75 bps at the July policy meeting. That would mark the largest move since 1998 when the Bank hiked 100 bps to defend a rapidly weakening Canadian dollar. Looking beyond the next policy meeting, we look for the BoC to hike rates 50 bps in September, followed by 25 bp rate hikes in October and December, and no further rate hikes thereafter. That would put the policy rate at 3.25% at year end, with the risks still skewed to a more aggressive path. Surging inflation paired with aggressive rate hikes are expected to weigh heavily on the economy in the latter part of this year, driving increasing caution from policymakers and the pause in rate hikes.

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