FOMC decision: Extended pause as Fed waits for economy and inflation to ease further
REAL ECONOMY BLOG | November 01, 2023
Authored by RSM US LLP
The Federal Reserve maintained its policy rate in a range between 5.25% to 5.5% at its November policy meeting on Wednesday.
Given the recent backup in Treasury yields, with the 10-year increasing by 124 basis points from 3.74% on July 19 to 4.98% on Oct. 19, the Fed intends to create policy space to ascertain the impact of higher financing costs while retaining a bias toward another hike.
But the market has priced in a low probability of the Fed’s hiking its rate in December and January at the next meetings of the Federal Open Market Committee.
We think that the Fed is done raising rates because of the tightening of financial conditions through the driving of yields higher over the past four months by investors.
More important, rising yields and the return of a positive term premium—sitting at 0.43% just before the policy announcement—back to positive terrain have resulted in tightening financial conditions that are the equivalent of a 50 basis-point hike by the Fed.
Market dynamics, easing inflation and what we anticipate will be a moderation in hiring strongly imply that the policy rate is sufficiently restrictive.
The Federal Reserve is well positioned to sustain an extended pause to give the economy time to absorb those higher borrowing costs, which are already hindering investment growth, and to assess recent economic data.
In our estimation, double-digit borrowing rates to finance payrolls and business expansion will cause the economy to slow below the long-term growth rate of 1.8% over the next six months, down from the torrid 4.9% rate in the third quarter.
For this reason, we think that the Fed is and should be done with its rate hike cycle. In addition, with long-run real rates rising—up to 2.5% using 10-year Treasury Inflation-Protected Securities as the benchmark—the central bank will soon need to focus on stabilizing those real rates and then bring them down starting in the second quarter of next year.
The policy statement had limited changes but included updated language to account for this year’s strong expansion and moderating job gains.
More important, the Fed kept the language around inflation remaining elevated and the text that stated, “In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, 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.”
That statement gives the Fed a bridge to a possible additional rate hike should inflation prove stubborn or accelerate.
Just as important, Federal Reserve Chairman Jerome Powell also reaffirmed that the central bank forecast does not include a recession.
While the Fed is in no hurry to hike rates further and is likely done, it has not yet declared a peak in the current hiking cycle.
Powell reaffirmed the Fed’s bias toward an additional rate hike if necessary. Most notably, Powell stated that growth persistently above potential or continuing tightness in the labor market could warrant additional tightening of monetary policy.
By stating that he thinks policy is not yet sufficiently restrictive, the central bank wants to communicate its policy bias even as inflation continues to ease.
For now, the Fed is not planning on hiking rates in the near term even if it is not yet ready to declare a peak.
From our vantage point, the lagged impact of past rate hikes and the recent 124 basis-point increase in long-term yields caused by a stronger economy and risks around fiscal policy will most likely result in the end of the current cycle.
We do not anticipate rate hikes at either the December or January policy meetings. Policy is likely to remain restrictive for the next six months at least before the Fed considers a potential pivot in monetary policy.
Contact us at one of our locations or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Joseph Brusuelas and originally appeared on 2023-11-01.
2022 RSM US LLP. All rights reserved.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Johnson & Sheldon, PLLC is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.