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Fed Downshifts to 50bp Hike

#Fed downshifts to a 50bp hike (as expected). They increased the key rate to 4.5%, the highest since 2007. According to Fed median forecast, projected rates would end next year at 5.1% (+50bps beyond the prior median of 4.6%) before being cut to 4.1% in 2024 - a higher level than previously indicated (see FOMC dots below). Prior to the decision, markets were expecting rates would reach ~4.8% in May.


POWELL: LABOR MARKET REMAINS EXTREMELY TIGHT
POWELL: A RESTRICTIVE POLICY STANCE LIKELY NEEDED FOR SOME TIME
POWELL: NEED SUBSTANTIALLY MORE EVIDENCE OF LOWER INFLATION
POWELL: FED STILL HAS SOME WAYS TO GO ON RATE HIKES
POWELL: STANCE ISN'T YET RESTRICTIVE ENOUGH EVEN W/ TODAY'S MOVE
POWELL: NO RATE CUTS UNTIL CONFIDENT INFLATION MOVING TOWARD 2%
POWELL: WILL HAVE TO HOLD RESTRICTIVE RATES FOR SUSTAINED TIME

Powell spent at least 7-8 minutes of the press conference endlessly repeating how hot the labor market is.


We also note some hawkish revisions to the inflation forecast with a majority of FOMC participants seeing core PCE decelerating to 3.5% at the end of 2023, versus a projection of 3.1% in the September forecast round. This also means that any good news on the inflation front ahead could cause policymakers to hike by less than shown in these projections.


So overall a hawkish message that investors don't fully buy is:

  • The dollar reversed some of its initial spikes;

  • Treasury yields mostly ended the day lower in yields, despite spiking initially on the FOMC statement. The short-end notably underperformed however (2Y +2bps, rest of curve down 1-2bps) which flattened the yield curve significantly;

  • The market is now pricing in rates being lower than current rates by Jan 2024;

  • The odds of a 50bps hike in Feb popped and then dropped (now at just 25%), while the odds of a March 25bps hike rose to 60%. There's a 76% chance that The Fed will not hike in May.

In other words, the bond market isn't buying Fed hawkishness. The Fed can change the Dot Plot all they want, but at this point in the cycle, the market believes there is no chance they’ll be able to keep rates above 5% for the entire of 2023.


So why the Fed message wasn't taken too hawkishly?


Answers:

  • Some words about the inflation target. Indeed, Powell said there could be a “longer-run project” in looking at the inflation target (but note the "longer-run", i.e "let's restore credibility first";

  • Powell said that we are 'getting close to sufficiently restrictive rates level".


Bottom line: The Fed remains hawkish and the statement takes back some of Powell’s perceived dovishness in his recent speech.


The clustering of dots for 2023 above 5%, with only two below that level, shows an FOMC on the same page to get the job done (at the risk of triggering a #recession). The fact that the market is not entirely buying this hawkishness is not necessarily good news -> "When the market just ignores the Fed, they have to do more:" ex-NY Fed President Bill Dudley said.