Fed Quick Take: How High (Higher), How Fast (It Depends), How Long (A While)?
Summary
The Fed hiked 75bps as expected. The statement included additional language around the pace of further tightening that suggested less perceived need for additional, very rapid increases. However, in the presser, Powell sought to send a hawkish message, framing the policy outlook in terms of how high rates would need to go, how long they’d need to stay there for, and how fast they’d get there. The latter question was de-emphasized in favour of focusing on the terminal rate, which Powell guided should be higher than anticipated in the September SEP. 75bps was not taken off the table for December, but it was also implied that the size of the December hike is not really the point. The Fed still has much more work to do.
We think the outcome is dollar bullish and see DXY pushing back above 112 over the coming sessions. We’d also maintain a 2s10s bear flattener bias. We will be revising our Fed subjective probabilities to include a higher terminal rate, and will publish a more fulsome discussion/reflection on the Fed in the coming days.
Fed Funds Rate and Statement
In line with our view and the consensus, the Fed hiked the target range for the Fed Funds rate by 75bps to 3.75%-4.00%, and the vote to do so was unanimous.
References to growth in spending and production, the labour market and inflationary pressures in the statement’s first and second paragraphs remained unchanged versus September.
Substantive new language was inserted in the third paragraph of the statement relating to the pace of hikes going forward:
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. 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.” – November FOMC Statement
From September: “The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3 to 3-1/4 percent and anticipates that ongoing increases in the target range will be appropriate.”
Presser: How Fast, How High, How Long?
In the presser, Powell sought to shift focus from the pace of hikes going forward towards the level of the terminal rate, and the duration for which the Fed persists at the terminal rate – both of which, he underscored, were unknown quantities. We see the following main takeaways from the presser:
Terminal rates: Some way to go until the Fed reaches a level which it considers sufficiently restrictive to align inflation with the target over the medium term. There is significant uncertainty around the appropriate terminal rate, but the bias is higher versus the September dot plot. The question of “how high” is the most important one to ask at this stage, with the question of speed becoming less important as the Fed approaches the (uncertain) terminal rate.
Talk of pausing is premature. When people hear talk of lags, they translate that through to pausing – this interpretation is premature.
Risk management assessment remains unchanged – the Fed still views the risks of doing too little as exceeding the risks of doing too much. If the Fed goes too far and overtightens, it can then use its easing tools, but allowing inflation to become entrenched would necessitate a much more painful response down the line.
75bps in December not off the table, but aggressive front-loading is less critical now that the Fed has delivered very substantial tightening year-to-date already. Powell sought to de-emphasize the pace of hikes going forward, in favour of the level of the terminal rate. The time to slow rate increases may come at the next meeting, or the one after that.
“As we come closer to that level (terminal rate), move more into restrictive territory, the question of speed becomes less important than the first two questions (how high, how fast)… let me say again, the question of when to moderate rate increases is now much less important than the question of how high to raise rates and how long to stay restrictive”. - Powell, Not Verbatim.
Rates and FX
Written at 19:34 London Time on 02/11.
DXY softened after the statement but rebounded during the presser and has strengthened somewhat on net. We think the dollar should push higher on most G10 crosses, and would anticipate DXY trading pushing comfortably back above 112 in the coming sessions. We’d anticipate weakness in EUR and GBP. On sterling, our bias is to believe that the BoE will raise rates by 75bps tomorrow, but the tone of the related communications is likely to stress long-term risks to the domestic economy and may therefore be taken as dovish, weighing on the cross. This is a bias – our conviction in this view is insufficient for us to initiate a trade.
US 10y yields are pushing higher – at around 4.1%, with 2s pricing in additional tightening and selling off to 4.61%. Over the next few sessions, particularly given the strong unemployment rate number which we’d expect on Friday, we think 2s10s could flatten more decisively than seen in the aftermath of the Fed so far. We’d look for 2s10s to push tactically further into inversion.
Statement
Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.
Russia's war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. 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. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lael Brainard; James Bullard; Susan M. Collins; Lisa D. Cook; Esther L. George; Philip N. Jefferson; Loretta J. Mester; and Christopher J. Waller.