Markets Boost Rate-Hike Expectations after FOMC Meeting Outcome

The FOMC on Wednesday, as expected, raised its federal funds target range by +75 bp to 3.75%-4.00%. That was the fourth consecutive +75 bp rate hike.

Stocks initially rose, and bond yields, fell on speculation that the pace of rate hikes would slow after the post-meeting statement said that "in determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments."

Wednesday’s post-meeting comments from Fed Chair Powell were initially construed as bullish when he said that the pace of hikes might slow as soon as the December 13-14 FOMC meeting as the Fed takes into account the delayed effect of past rate hikes.  However, stocks reversed course Wednesday and plunged after Powell said we still have "some ways to go" on interest rates and that the ultimate level of the terminal rate may be higher than previously expected.

Fed Chair Powell’s comments Wednesday suggested that even if the Fed slows the pace of its rate hikes, interest rates will have to higher than the Fed earlier thought.  Powell said the FOMC is aiming for tightening policy that’s “sufficiently restrictive” to return inflation to 2%.

In the wake of this week’s FOMC meeting, market expectations are now for the FOMC to raise rates by +50 bp at the December meeting and by another +50 bp at its January 31-February 1 meeting, followed a further 25 bp increase at its March 21-22 meeting.  The June fed funds futures (ZQK23) contract is currently pricing in a peak federal funds rate of 5.12%, which is up by just over +125 bp from the current effective federal funds rate.  Prior to this week’s FOMC meeting, the markets were expecting only another +100 bp worth of rate hikes.

At the September FOMC meeting, the Fed’s dot-plot indicated that FOMC members were forecasting a peak federal funds rate of 4.60% by the end of 2023. However, that peak is likely to be revised higher to the 5% area when the FOMC next releases its next dot-plot at the December 13-14 FOMC meeting.

Comments from Fed Chair Powell signal there is plenty more to be done before policymakers can be sure they have raised rates far enough.  Schroders Plc expects the fed funds rate to at least match the 5.1% annual core inflation rate reflected in the most recent personal consumption data, a key measure the Fed tracks.  The markets have been underestimating where the peak Fed rate is going to be.  Three months ago, the highest point on the federal funds futures curve was about 3.5%.  The peak rate is now just above 5%, but the risks may be skewed to the upside after Wednesday’s comments from Fed Chair Powell.

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