Hawkish Fed, untamed inflation

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As widely expected, the Federal Open Market Committee increased its policy rate by 50 basis points to 4.25%-4.50% on Wednesday, as it downshifted from the 75 bps hikes of its previous four meetings. While that would appear to be a win for investors, the so-called “dot plot” was more of a concern. The Fed policymakers’ median projection now sees the federal funds target range rising to 5.1% next year – a level last seen in 2007 – compared with 4.6% in the central bank’s September projection.

Quote: “We need to be honest with ourselves that there’s inflation. 12-month core inflation is 6% CPI. That’s three times our 2% target. Now it’s good to see progress, but let’s just understand we have a long ways to go to get back to price stability,” Fed Chair Jerome Powell said during a press conference. “I don’t think anyone knows whether we’re going to have a recession or not, and, if we do, whether it’s going to be a deep one or not. It’s just – it’s not knowable… The historical record cautions strongly against prematurely loosening policy. We will stay the course, until the job is done.”

All three major U.S. stock indices retreated following the announcement, erasing gains from earlier in the session. By the end of the day, the Nasdaq slipped 0.8%, and the S&P 500 and Dow fell 0.6% and 0.4%, respectively, while more losses are in store premarket. Rate hikes are tricky in the sense that monetary policymakers may not know for another year if they have tightened too much or not enough (economists call those effects long and variable lags).

Commentary: “The Federal Reserve’s decision to reduce the pace of rate hikes to 50 bps marks the beginning of the end of this rate hike cycle,” said SA contributor Ahan Vashi. “However, a reduction in pace of rate hikes is not a pivot, and the Fed’s quantitative tightening program is likely to continue for the foreseeable future. With the Fed tightening into a deeply inverted treasury yield curve, the near-term environment should be risk-off. Hence, equity markets could see increased volatility in upcoming weeks.”