Still Too High: Fed Not Happy with Inflation, Promises Longer Runway For Rates to Rise

(Wednesday Post-Fed) The Federal Reserve’s rate decision today wasn’t a curveball for the market. Its 50-basis-point hike was right down the middle, putting the federal funds rate in a range between 4.25% and 4.5%.

What might have spun Wall Street around—at least initially—were the Fed’s projections for future rate hikes and economic conditions. These bearish forecasts sent the market down about 1% in the minutes after the rate announcement.

A late rebound from initial selling might be related to thinking that the Fed is now closer to its peak and may be able to slow hikes in 2023, even if the peak ultimately ends up being higher than analysts had anticipated.

Still, the post-announcement Wall Street recovery looked unsteady as the Fed’s post-meeting statement and Fed Chairman Jerome Powell’s press conference generally threw a wet blanket on Wall Street’s holiday spirit. By the end of the day, the recovery failed and stocks closed down, though off their earlier lows.

‘Pivot’ Postponed

The central bank showed no sign of any “pivot” to lower rates in the near future, instead delivering a firm message that rates aren’t nearly high enough yet to tame inflation, need to go higher, and perhaps stay there longer. Rates above 5% by the end of next year are now penciled in by the Federal Open Market Committee (FOMC) with no hints of rates coming down until 2024.

That’s a more bearish picture than market participants had baked in; some analysts were expecting rates to begin ticking down in late 2023.

The FOMC now sees a terminal, or peak, rate of between 5% and 5.25% by the end of next year, up about 50 basis points from the previous terminal rate projection in September. This reflects ideas that overheating—particularly in the services part of the economy—continues to push prices higher. Specifically, the Fed has its eyes on wages and housing.

“We see a very strong labor market where jobs growth and wages are very high, vacancies are very elevated, and there’s an imbalance of supply and demand,” Powell said in his remarks to the media. “That is likely to take a substantial period to go down.”

The goal is to take the Fed’s policy to a level where it restricts inflation, and the Fed won’t consider rate cuts until it’s convinced inflation is “coming down in a meaningful way,” Powell said.

The question now, he said, is less about how quickly the Fed raises rates and more about finding the right level that puts inflation on a sustainable downward path. Powell made it very clear the current rates, even with today’s hike, aren’t close to that level yet.

Even by the end of 2024, the Fed’s dot-plot sees rates between 4% and 4.25%, not much below current levels.

Economic Projections Get Uglier

The Fed’s economic projections also disappointed market participants:

• The FOMC now sees Gross Domestic Product (GDP) growing just 0.5% next year, down from its prior 1.2% projection.
• It also raised its 2023 unemployment rate estimate forecast to 4.6% from the previous 4.4%.
• Core Personal Consumption Expenditures (PCE) inflation, the Fed now said, will be 4.8% in 2022, up from its previous 4.5% outlook.
• The Fed expects core PCE of 3.5% in 2023, up from its previous 3.1%.

Weaker economic growth forecasts and higher inflation projections raise questions about the path of corporate earnings, with many analysts already saying the 5% earnings growth expected by Wall Street for 2023 may be overdone. This could weigh on the market.

The Fed doesn’t see inflation getting back toward its 2% goal until 2025 and said inflation risk is still to the upside.

Though inflation expectations among consumers remain well anchored, “the longer the current bout of high expectation continues, the greater likelihood that expectations of even higher inflation in the future will become entrenched,” Powell warned in his press conference.

On a more positive note, goods inflation does show signs of improvement, according to Powell.

Within an hour of the Fed decision, markets had clawed back their losses, and the 10-year Treasury yield was back below 3.5%. Compared to the steep sell-off following the FOMC’s November 1-2 meeting, this reaction seems milder.

The Year Rates Woke Up

Today’s rate hike was the Fed’s seventh of the year, and its second hike of 50 basis points.

• The process began on March 17 with a 25-basis-point increase, taking rates up from near zero where they’d been parked since COVID-19 slammed the economy shut in March 2020.
• The Fed followed with a 50-basis pointer in May, and then an unprecedented four consecutive 75-basis-point hikes in June, July, September, and November.
• Today’s rate increase puts the fed funds rate at levels last seen in late 2007, but at that time, the Fed was in the process of lowering rates just as the Great Recession of 2008-2009 was taking hold.
• The last time it raised rates to above 4% was in December 2005. That was when the Fed was trying to snuff the bubble developing in the real estate market, but higher interest rates didn’t do the trick. Only a massive recession popped that bubble.

Today, investors hope the Fed can engineer a “soft landing” where higher rates only snuff out inflation, not the economy as a whole, but that’s a very difficult task.

Numbers to Know 

230,000: Tomorrow morning brings November’s Retail Sales report before the open (see below) and a look at initial weekly jobless claims. Last week, the initial claims tally was 230,000, and Wall Street analysts expect Thursday’s number to be in that ballpark.

1.671 million: However, the more important data point to watch for in the claims report could be continuing claims. Those rose for an eighth straight week to 1.671 million in the last week of November, the highest since the week ending February 5. Initial claims, however, averaged 224,000 so far in Q4, a level consistent with a tight labor market, according to economic data site Trading Economics.

Reviewing the Market Minutes

Here’s how the major indexes performed today:

• The Dow Jones Industrial Average® ($DJI) dropped 142 points, or 0.42%, to 33,965.
• The Nasdaq® ($COMP) dropped 0.76% to 11,171.
• The Russell 2000® (RUT) dropped 0.7% to 1,819.
• The S&P 500® index (SPX) fell 24 points, or 0.6%, to 3,995.

Grabbing Food After a Fill-Up: The FOMC meeting is over, and the Consumer Price Index (CPI) data is in the rear-view mirror, but the week still has some big data in store—or stores, to be more precise. November retail sales are due before Thursday’s opening bell. Back in October, retail sales jumped a massive 1.3% (also 1.3% excluding automobiles), but Wall Street expects a sharp November pullback. The consensus view is for a 0.1% decline in the headline number and a 0.2% increase in retail sales excluding autos, according to research firm Briefing.com.

It’s an important report because it’ll provide clues to whether October’s surge following an unchanged monthly number in September was some sort of blip or the start of a new higher trend in consumer spending. Food and beverage sales played a big role in the October bump; so did gas stations. Food price growth didn’t retreat much in November, according to the CPI data, but gas prices did fall. 

Remember that retail sales aren’t adjusted for inflation, so slower inflation growth should help put the thumb on the scale for tomorrow’s data.

Notable Calendar Items

Dec. 15: November Retail Sales, December Empire State Manufacturing, and November Industrial Production and Capacity Utilization

Dec. 16: Expected earnings from Accenture (ACN)

Dec. 19: No earnings or data of note

Dec. 20: November Housing Starts and Building Permits and expected earnings from General Mills (GIS) and Nike (NKE)

Dec. 21: November Existing Home Sales and expected earnings from Rite Aid (RAD) and Micron (MU)

Dec. 22: Government’s final Q3 GDP estimate and expected earnings from CarMax (KMX)

Dec. 23: November Durable Orders, November Personal Income and Spending, November PCE Prices, November New Home Sales, and Final December University of Michigan Consumer Sentiment

 

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