• Fed keeps the target range of FFTR unchanged at 5.00%-5.25%

• Fed clearly delivered a hawkish hold

• Dot plot indicates strong support among policy members for further hikes

• Expect the Fed to hike one final time by 25bps in July and pause thereafter

The Federal Open Market Committee (FOMC) refrained from hiking rates at its 13/14 June policy meeting, which is the first time in 11 meetings that the Committee left the fed funds rate unchanged at 5.00%-5.25%. The FOMC also decided to keep its pace of quantitative tightening unchanged. That is, the Federal Reserve will allow up to USD60bn of Treasury securities and up to USD35bn of mortgage-backed securities to roll off its balance sheet every month.

The post-meeting statement was little changed from the last statement on May 3. The Committee continued to note that economic activity is expanding at a “modest pace” and that unemployment remains low and inflation “remains elevated”. The FOMC said that its decision to keep rates on hold would give it the ability “to assess additional information and its implications for monetary policy”. The Committee re-iterated the phrase that it first used in the May 3 statement. That is, it will consider a number of factors to determine the extent that “additional policy firming may be appropriate to return inflation to 2 percent over time”. These factors include “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”.

Dot Plot Shifts Up

According to the Summary of Economic Projections (SEP), which the FOMC releases four times per year and outlines its macroeconomic forecasts, most members of the Committee believe that additional policy firming may be appropriate this year. That is, the so-called “dot plot” that was released following the March 22 meeting showed that the median FOMC member thought that a fed funds target range of 5.00%-5.25% would be appropriate at the end of 2023. The dot plot that was released in June showed the median dot shifting up to a range of 5.50%-5.75% at the end of this year. In other words, the median FOMC member believes that another 50bps of tightening will be needed by the end of the year “to return inflation to 2 percent over time”.

For 2024, the distribution of the projections gets wider with FOMC members’ median projection that rates would fall to 4.3%, compared to the 4.1% as previously indicated in Mar FOMC. This continues to imply that the terminal FFTR would be held through 2023 before expectations for rate cuts in 2024 and 2025 (at 3.4% from 3.1% in Mar FOMC). The median longer run FFTR projection remained at 2.5% (unchanged from Mar and Dec FOMC).

Why the change in the dots? The answer: the FOMC changed its forecasts of unemployment and inflation in its latest Summary of Economic Projections (SEP). The unemployment rate remains exceptionally low at present, and the Committee now sees it rising to only 4.1% by the end of 2023 (the median participant in March forecasted it rising to 4.5% at the end of the year). The unemployment rate will edge higher to 4.5% in 2024 and 2025 (versus 4.6% made previously in March SEP), with the longer run unemployment rate remaining anchored at 4.0% (unchanged since June 2021 SEP).

Additionally, the median forecast for the core rate of PCE inflation at year-end 2023 was lifted from 3.6% in March to 3.9% in June. Headline PCE inflation was lowered slightly in 2024 to 3.2% from 3.3% previously and held at 2.5% and 2.1% in 2024 and 2025 respectively. Interestingly, none of the 18 FOMC members at present thinks that a rate cut by the end of the year would be appropriate.

Looking at the latest SEP, the adjustments made suggest that the FOMC members were more bullish on this year’s growth with GDP growth in 2023 revised markedly higher to 1.0% from 0.4% projected previously in Mar. Growth outlook is trimmed slightly in 2024 (1.1%) and 2025 (1.8%) by 0.1ppt.

What will the FOMC need to see to start easing policy? Barring some unforeseen negative shock to the economy in the near term, the Committee wants to see evidence that inflation is returning to 2% on a sustained basis. The rate of inflation has eased marginally in recent months but only an optimist would look at that chart and see evidence that inflation is returning to 2%. In our view, the year-over-year rate of inflation does not need to be precisely at 2% before the Committee begins to ease policy. The forecast for core PCE deflator is to increase at an annualized rate of 2.8% QoQ in 4Q, which we think is still too hot to induce the FOMC to cut rates. Consequentially, we do not look for a rate cut this year, which is consistent with the FOMC’s thinking at present.

Expect the Fed to hike one final time by 25-bps in the Jul 2023 FOMC and pause thereafter

The next FOMC meeting is scheduled for July 26. We expect that the continued resilience of the economy and the elevated rate of inflation will lead the Committee to hike by another 25 bps at that meeting. Indeed, Chair Powell stated in his post-meeting press conference that the July FOMC meeting will be a “live meeting”. We then look for the Committee to remain on hold for the remainder of the year. However, given June’s dot plot, we readily acknowledge that the risks to our fed funds forecast are skewed to the upside. We think it will take a modest recession early next year, which will help to bring inflation lower, to induce the FOMC to ease policy.

Source: BIMB Securities Research - 16 Jun 2023