19/09/2023
FOMC expected to leave
rates on hold
- A pause but rates may not have peaked
- Focus on the dots and the language from Powell
- Higher for longer but this is the moment to shift focus from higher to longer
The
Fed is a certainty to pause – 99% implied by fed funds futures. The main question
overhanging the meeting is on the dot plot, whether policymakers think they have hit the
peak in rates and the big question over duration. With the latest round of economic
projections due we will see whether policymakers still see one more hike this year, and
their outlook for the key argument over duration. If the dots are the same as
June
, markets could
move to price in a higher likelihood the Fed hikes in November – currently one in three –
and push back on when they think the Fed starts to cut. If the median dot is lower than the
5.6% forecast in June, then it could be the signal to the market that the Fed is done, with
the current target rate at 5.25-5.50%. This may be taken as a dovish signal so Powell would
need to sound hawkish in the presser to counter. My preference is for dots in 2023 to be
unchanged – even if the Fed does not actually hike again this year – and higher in 2024 and
2025 as the Fed lays the groundwork for keeping policy rates at this level all next year. To
borrow a phrase from a while back, the Fed isn’t even thinking about thinking about cutting
rates. We may see the median 2024 dot raised to close to 5% from 4.6% in June. Growth rates
for this year and next should also rise and provide counterbalance to maintaining rates,
which would suggest the Fed is minded to believe the US economy has ‘got this’. 
In terms of the statement, I’d expect the Fed to stick to the
view that ongoing hikes “may be appropriate” as opposed to “data dependent” – the latter
would be seen as a signal that the Fed thinks it has peaked. Should the Fed feel
comfortable? CPI was up 0.6% on a monthly basis, driven by higher gasoline prices. Super
core was still rather hot – core services ex-shelter at +0.5% mom from +0.2% in July.
Year-over-year the core came down to 4.3% as expected from 4.7% which ought to be positive
for the Fed. Surging oil prices are a new complication that will nudge anyone on the fence
towards the hawkish consensus. UoM year-ahead inflation expectations fell to 3.1% from 3.5%
last month. The reading is the lowest since March 2021 and is just above the 2.3-3.0% range
seen in the two years prior to the pandemic. Long-run inflation expectations came in at
2.7%, falling below the narrow 2.9-3.1% range for only the second time in the last 26
months. In comparison, long-run inflation expectations ranged between 2.2 and 2.6% in the
two years pre-pandemic. 
Breakevens are falling 
As inflation comes down the policy rate gets more restrictive
– this will be the key for duration question and a lot of technicalities about when members
think they should cut will be about this relativity. Real rates are at their highest in
about 14 years. 
But the Fed is also coming up against an addiction to cutting
– since last September financial conditions have loosened since rather than tightened. 
This makes it incredibly difficult to force inflation much
lower – partly it’s about the emergency response to the banking crisis in March, which has
refilled the liquidity tank, and partly it’s because the market continues to price in cuts
next year. As I’ve mentioned a few times here, there is a big question about what the Fed
and other central banks are prepared to tolerate in terms of inflation – if they expect to
cut next year and project inflation still being too high there is an admission of not
getting back to 2%. So, one of the main tasks for the Fed and its chair, Jay Powell, is
going to be to reiterate the higher for longer message and three-line whip the 2% inflation
target. Whether the FOMC has hit the top, the emphasis now is on ‘longer’ rather than
‘higher’. 
Neil
Wilson
Chief Market Analyst at Finalto
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