Highly anticipated ‘skip’
For the first time since January 2022, the FOMC unanimously decided to keep rates steady, maintaining the target range for federal funds rate at 5.00-5.25%. Their reasoning was to assess additional data and implications for monetary policy.
Alongside the FOMC statement, the Summary of Economic Projections (SEP) drew considerable attention as the median projection for the end of 2023 saw an increase of 50 basis points to 5.6% from the March projections. Similarly, projections for 2024 and 2025 were raised by 25 basis points, with 16 of 18 FOMC participants in favour of further policy rate hikes this year.
Figure 1. FOMC participants’ assessments of appropriate monetary policy
Source: Federal Reserve
On the growth front, the 2023 projection received a substantial boost, rising to 1.0% QoQ, while 2024 and 2025 projections were marginally adjusted down. Notably, unemployment rate projections for 2023 were marked down to 4.1%, a reduction of 40 basis points.
Despite the decision to hold rates steady, the market reacted strongly to the raised projections for 2023, causing a sell-off in US rates, a brief surge in the US dollar, a dip in equities, and a widening in credit spreads.
Chair Powell, during the press conference, responded to questions about holding rates steady at a time of high core inflation. He emphasized that as the Committee neared its target, the pace of hikes has decelerated, adding that not every meeting would necessarily see a rate hike. As Powell's comments during the press conference seemed to contrast with the June SEP's individual assessments, these initial market reactions faded.
Looking ahead
As the FOMC decision clearly demonstrates, policy lags are a significant challenge for the central banks. Policy makers are still concerned about stopping monetary tightening too early and leaving the door open for inflationary pressures to re-emerge.
In our view, however, the macro environment remains unusually complex. Recession probability models factoring in leading indicators, such as the manufacturing purchasing managers' index, yield curve and University of Michigan Consumer Confidence, suggest to us that the likelihood of a recession remains higher than average.
While the labor market has remained persistently strong, we would argue that given the labor shortages experienced throughout the pandemic, coupled with the ongoing labor scarcity, corporations may be inclined towards retaining their workforce longer as compared to previous cycles.
Having said that, in our view, the tightening cycle will eventually result in sluggish growth and weaker earnings outlook. The full effects of policy tightening are still clearly gradually feeding through. We are seeing many symptoms of monetary tightening effectively biting and impacting the real economy. Further deterioration in the macro environment affecting real estate and other interest rate sensitive segments of the economy is a significant risk.