50 Ways to Leave Your Mark
The Fed made no changes to its interest rate or balance sheet policies; but some of the language in its statement was tweaked, reflecting recent hotter inflation data.
Underscoring a bit of a hawkish tilt, the FOMC—in its dots plot—signaled they now expect two interest rate increases by the end of 2023.
Despite continued progress in the labor market and an increasing pace of inflation, Chairman Jerome Powell reiterated that the Fed will be transparent in signaling when a tapering in asset purchases is to come.
As expected, the Federal Open Market Committee (FOMC) raised the fed funds rate by 50 basis points, to a range of 0.75% to 1.0%. It was a unanimous decision (somewhat surprising given the chatter about a 75-basis-point hike being on the table), and the largest rate increase since 2000. In addition, the pace of balance sheet "runoff" (quantitative tightening, or QT) will start on June 1 at $47.5 billion/month, increasing to the previously stated maximum of $95 billion/month after three months. At first blush, the decision and statement were in line, and not more hawkish, as some were expecting. Most of the markets' reactions occurred after the press conference began, with stocks rallying, and bond yields and the dollar falling.
Notables within the FOMC statement started with the first line, which shifted to an acknowledgement of weak economic growth in the first quarter; but it also highlighted healthy household spending and business capital spending. The statement also reiterated concerns about the Russia/Ukraine war keeping inflation elevated, while also noting that "COVID-related lockdowns in China are likely to exacerbate supply chain disruptions." The addition of the FOMC being "highly attentive to inflation risks" was seen as at least marginally more hawkish.
The balance sheet runoff was detailed in a separate note, and was for the most part in line with what was discussed at the March FOMC meeting. Treasury securities will be reduced by $30 billion/month to start, and increased to $60 billion/month after three months. Mortgage-backed securities will be reduced by $17.5 billion/month to start, and increased to $35 billion/month after three months.
As usual, this report covers the first 30-40 minutes of the press conference in the interest of getting it into the publishing queue. There are always important nuggets in Jerome Powell's press conferences, but arguably, today's was seen as more consequential. Some key highlights:
- Before taking questions, Powell made some formal remarks, highlighting that "high inflation poses significant hardship," especially for lower-income Americans.
- He echoed the statement about the Russia/Ukraine war exacerbating uncertainty.
- The balance sheet will "play an important role" in firming the stance of monetary policy and that the FOMC will make their "decisions meeting-by-meeting."
- The Fed is "strongly committed to restoring price stability" with Powell saying 50-basis-point hikes are on the table for the next couple of meetings.
- Out of the blocks, Powell was asked about the labor market and although he believes the unemployment rate could decline a bit more, he does expect employment gains to slow, with more Americans expected to enter (or re-enter) the labor market.
- Powell said there are reasons to believe that a "softish" landing is possible, citing the strength of household and business balance sheets—but expressed without a tone of high confidence.
- He said that a 75-basis-point hike is "not something the committee is actively considering" (the front-end of the Treasury curve reacted, with a meaningful decline in the two-year yield.)
- When asked about the near-term trajectory of inflation, Powell said there is some evidence that core PCE is at or near a peak.
- A simple inflation peak would not be sufficient, with Powell noting that core inflation needs to come down for at least a couple of months, after which it would be a "judgment call" as to going back to 25-basis-point hikes.
- Powell will continue to monitor how tighter financial conditions are impacting the economy and "if higher rates are required, we won't hesitate to deliver them" … adding that the Fed can't “allow a wage-price spiral."
- He did differentiate between short-term and long-term inflation expectations, noting that the latter have only increased to 2014's levels.
- Powell also noted that the Fed's "tools don't really work on supply shocks, [they] work on demand." (As an example, they can't impact oil or food prices.)
- He said there is plenty of work to do on the economy's demand side, which the Fed can affect.
- Powell conceded the Fed's "difficult situation" given that they "have to be sure that inflation expectations remain anchored."
- He said the Fed doesn't have specific labor market goals, but that we've "got to get to a place where the labor market is more in balance."
- "It's not going to be pleasant" as the Fed raises rates to battle inflation, but "everybody will be better off in time."
- "Without price stability, the economy doesn't work for anybody."
- Finally, Powell suggested that history's test wasn't whether former Fed Chair Paul Volcker was prepared to tip the economy into a recession to combat 1970s-era inflation, but that the test (then and now) is really about doing "the right thing."
There were few surprises in the statement, but more details were fleshed out during the press conference. Although the Fed addressed the contraction in the economy in the first quarter, it focused more on the strong gains in final sales to households and businesses. For what it's worth, we believe the risk of recession is elevated and should not be dismissed. Expectations are that the Fed will hike rates by a similar amount at the next couple of FOMC meetings.
Stocks were choppy-to-weak following the announcement, but began to rally as the press conference unfolded. We expect continued bouts of volatility associated with both monetary policy and the trajectory of inflation and economic growth. Courtesy of still-strong earnings growth, and a weak four-month start to the year, valuations have come down notably. However, expectations looking ahead are for another deceleration in growth in the second quarter, as well as a likely long-awaited hit to profit margins.
We continue to recommend investors keep portfolio risk to levels no higher than strategic asset allocations, remain diversified (across and within asset classes), focus on high quality fundamentals, and utilize periodic rebalancing to take advantage of volatility by "adding low and trimming high."