More to Hike

By Nicholas Jasinski  |  Wednesday, September 21

Higher and Higher. Today was all about the Federal Reserve and interest rates, but the market wasn't sure what to think of it all at first. Stocks swung violently after the Fed's announcement before declining sharply late in the day.

The central bank increased its federal-funds rate target by 0.75 percentage point, to a range of 3.00% to 3.25%—the highest since early 2008. Futures markets had been pricing in a roughly 75% likelihood of such a move and about 25% odds of a full percentage point increase.

Fed officials out-hawked the market on their expectations of what comes next, however, in their Summary of Economic Projections. Their median forecast is for the fed funds rate to rise to 4.4% by the end of this year, then 4.6% in 2023. Those numbers had been 3.8% and 3.4% in the June dot plot. Futures markets had been pricing in a 4.5% peak early next year, then a decline to close to 4% by the end of 2023.

If accurate, the latest projections would mean another 1.5 percentage points, or 150 basis points, of rate increases from here. That could put a fourth-straight 75 basis point hike on the table for November (just six days before the midterm elections), followed by 50 basis points in December and 25 basis points in February. Then the Fed may take a pause to allow its more restrictive stance to impact the real economy. Monetary policy famously acts with "long and variable lags," after all.

"Restoring price stability will likely require maintaining a restrictive policy stance for some time," Fed Chair Jerome Powell said in his prepared remarks this afternoon "The historical record cautions strongly against prematurely loosening policy."

Fed officials see interest rates declining over the longer term, to a median of 3.9% in 2024 and 2.9% in 2025. That's as the median dot has the PCE inflation rate falling from 5.4% this year to the Fed's 2.0% target in 2025.

That won't be painless, however, the Fed chair cautioned today. "Reducing inflation is likely to require a sustained period of below-trend growth," Powell said. "There will very likely be some softening of labor conditions."

That's a necessary cost to bear in order to conquer inflation, Powell continued.

The median dots call for U.S. real gross domestic product to increase 0.2% this year and 1.2% next year, down from median projections of 1.7% in both years back in June. Officials' median prediction is for unemployment to end 2022 at 3.8% before rising to 4.4% in both 2023 and 2024.

"I think where a lot of people are missing the mark is okay, perhaps we've had peak inflation...but that's not what the Fed needs to see to change monetary policy," Per Sterling Capital Management's Robert Phipps told me today. "They have told us very clearly, they want to see multiple months of data that confirm that inflation has peaked and that it is returning to their 2% target."

That's the higher-for-longer message sent by the Fed today. And the longer that monetary policy remains in territory that restricts the economy, the more likely downside there is for stocks.

As for today, at first investors couldn't quite figure out to do with the news. The S&P 500 was up about 0.8% before the FOMC statement was released at 2 p.m., then immediately began falling as the release crossed the wires. It dipped to a loss of 0.9% on the day, then began rising again as Powell began his press conference at 2:30 p.m. The S&P 500 had climbed to its highs of the day some 15 minutes in, up 1.2%.

The index didn't hold on to those gains for long. Stocks embarked on a one-way trip down for the remainder of the afternoon. The S&P 500 closed down 1.7%, the Dow Jones Industrial Average lost 1.7%, and the Nasdaq Composite shed 1.8%.

Over in the bond market, short-term Treasury yields rose—the 2-year note yield is now at 3.99%—which reflects the now-higher rates expected in the near term. But longer-term yields fell today, pricing in slower economic growth over the course of the coming cycle.

 

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