Markets lost their earlier gains following a hawkish interpretation of the Fed meeting.   As expected, the Central Bank increased the overnight rate by 0.50% to 4.5%.  However, it also boosted its terminal rate target to 5.1% from 4.65% that was projected in September.  Before the outcome of meeting, the markets were suggesting an apex around 4.85%.

The distribution of rate forecasts also skewed higher with seven of the 19 officials seeing rates above 5.25% next year, a level which spooked the markets.

Fed officials also raised their estimates for the main and core reading of their preferred inflation gauge.  They now see the PCE at 3.1% in 2023 compared with a September estimate of 2.8%, while core—which excluded food and energy—may be 3.5% for the next year.

The FOMC statement retained language saying “ongoing” hikes will be appropriate to reach “sufficiently restrictive” stance that returns inflation to 2% over time.

As noted, several times there is a disconnect between Fed policy statements and market expectations.  The CPI-fixing swap market currently pegs March CPI at 4.4%.  The same swap is suggesting a headline rate of 2.4% by June.

To write the obvious, the Fed Funds rate must exceed the inflation rate to be deemed restrictive.  Every post WW II tightening cycle has ended with the real fed funds rate in positive territory by an average of 3.51% with a range between 0.32% and 7.55% according to Bloomberg.

If inflation (defined as the core PCE) subsides to the 3.5% level as projected by the Fed, to meet the post WW II average the overnight rate would increase to 7.0%.  A 5.1% overnight rate would be the third lowest real funds rate on record based upon the above assumptions.

FRB Chair Powell indicated policy will need to remain tight [restrictive] for “sometime” to restore price stability, perhaps crushing market expectations of a pivot in mid-2023 as the FOMC is now forecasting a 5.1% rate at year end of 2023.  The Committee is expecting rates to be cut to 4.1% “sometime late 2024,” a higher level and longer period at this level than previously indicated or believed.

The Fed Chief further stated that the Committee requires more evidence beyond October and November’s softer consumer price index numbers to have confidence that inflation is coming down meaningfully, elaborating the size of February’s rate hike depend on incoming data.

As stated above, following a moderately volatile sessions equites fell about 0.70% on the outcome.  The Treasury market was equally volatile with yields closing moderately higher.

What will happen today?

Last night the foreign markets were down.  London was down 0.46%, Paris down 1.06% and Frankfurt down 1.09%.  China was down 0.25%, Japan down 0.37% and Hang Seng down 1.55%.

Futures are down about 1% on realization that the Fed may not pivot in the intermediate future and the peak rate may be considerably higher than market expectations.  The 10-year is off 1/32 to yield 3.48%.


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