February Fed Meeting: FOMC Delivers Smaller, Gentler Rate Hike

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In a widely anticipated move, the Federal Open Market Committee (FOMC) has raised the fed funds target rate by 25 basis points (bps), to a new range of between 4.50% and 4.75%.

The 25 bps hike at the FOMC meeting on February 1 marks another deceleration in the pace of the Federal Reserve’s monetary policy tightening campaign. The central bank had raised rates by 50 bps in December and 75 bps at each of its previous four meetings.

The Fed also confirmed that it would continue to allow up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities (MBS) to mature and roll off its more than $8.5 trillion balance sheet every month, another key component of its ongoing battle against inflation.

A combination of pent-up consumer demand, supply chain disruptions and a tight labor market sent inflation soaring to 40-year highs last year. The FOMC has been raising interest rates since March 2022 in an attempt to bring inflation down to its 2% long-term target.

Fortunately, inflation has been trending steadily lower over recent months, allowing the Fed to take its foot off the gas and opt for smaller rate hikes. Investors are optimistic the central bank is approaching its terminal interest rate of the current cycle—the point when it stops hiking and takes a pause—although economists anticipate at least one more rate hike in March.

Inflation Is Finally Cooling Off

The FOMC is attempting to deliver a “soft landing” for the U.S. economy: Tightening monetary policy to bring down inflation without setting off a recession. Higher interest rates increase borrowing costs for companies and consumers, slowing the economy and weighing on corporate earnings growth.

Last month, the Labor Department reported the consumer price index (CPI) rose 6.5% in December, down from a 7.1% gain in November and a 40-year high of 9.1% in June.

Last week, the Commerce Department reported the core personal consumption expenditures price index (PCE) was up 4.4% in December, down from a 4.7% year-over-year gain in November and a 2022 peak of 5.3% in February. Core PCE is the Federal Reserve’s preferred inflation measure, and its long-term target for core PCE inflation is just 2%.

“While recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path,” Fed Chair Jerome Powell said in his post-meeting press conference on Wednesday.

The U.S. labor market has remained tight, making the Fed’s fight against inflation more difficult. The Labor Department reported the U.S. economy added 223,000 jobs in December, exceeding economist expectations of 200,000 new jobs. Wages were up 4.6% year-over-year in December, and companies often pass on higher labor costs to customers by raising prices on goods and services.

“We continue to anticipate that ongoing increases in the target range for the federal funds rate will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time,” Powell said Wednesday.

Powell said it’s good news that declines in inflation in recent months have not come at the expense of a weaker labor market but acknowledged that the impact of the Fed’s tightening measures will likely have a lagging negative impact on the economy.

“Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions,” he said.

A Mixed Economic Outlook

Fed economists are anticipating a difficult year for the U.S. economy in 2023. In December, Fed officials projected a terminal fed funds interest rate of 5.1% in 2023 and indicated the FOMC would not pivot from rate hikes to rate cuts until 2024.

The committee projects a 2023 U.S. unemployment rate of 4.6%, up from the 3.5% level the Labor Department recently reported. U.S. GDP grew 2.9% in the fourth quarter, but the Fed projects that growth will slow to just 0.5% in 2023 and 1.6% in 2024.

While inflation will likely continue to trend lower, the Fed projects core PCE inflation of 3.5% this year, still well above its 2% target.

Rising interest rates triggered a sell-off in stocks and other risk assets in 2022. The S&P 500 generated a total return of negative 18.1% in 2022, its worst annual performance since the global financial crisis in 2008.

The stock market is off to a strong start in 2023 thanks in large part to fourth-quarter earnings numbers that aren’t as bad as many investors had feared. S&P 500 companies are on track to report a 5% year-over-year decline in earnings in the fourth quarter. Analysts are expecting negative earnings growth to continue through at least the first two quarters of 2023.

Stock prices rebounded from intraday lows on Wednesday following the FOMC announcement.

What’s Next for Fed Policy?

According to CME Group’s FedWatch, markets are currently pricing in an 82% chance the Fed will raise interest rates by another 25 bps at its March meeting. However, investors and central bankers have roughly seven weeks of economic data to monitor between now and then that could have a significant impact on monetary policy.

Bill Adams, chief economist for Comerica Bank, says the Fed’s language suggests it is approaching the end of its hiking cycle.

“The Fed is still guiding expectations toward a terminal rate of at least 5.00% to 5.25%, not the 4.75% to 5.00% range that markets have been contemplating as the peak in recent weeks,” Adams says.

Richard Carter, head of fixed interest research at Quilter Cheviot, says inflation spiked higher in 2022, but it will likely decline back to normalized levels at a much slower pace.

“As a result, markets will continue to be on edge as every move by the Fed is overanalyzed for clues about future direction. Despite the rally we have seen in markets during January, volatility will be ever present until we get that certainty about the economy and the impact of higher interest rates for longer,” Carter says.

In the near term, investors will be watching for the January U.S. jobs report on Feb. 3 for an update on how rising interest rates are impacting the labor market. Several big-name tech companies issued layoffs in January, including Microsoft (MSFT), Amazon (AMZN) and Alphabet (GOOG, GOOGL). In fact, 154 tech companies fired more than 55,225 employees in January, more tech layoffs than occurred in the entire first half of 2022.

In addition to the jobs report, investors hope to confirm inflation is still trending lower when the Bureau of Labor Statistics releases its January CPI reading on Feb. 14.

Federal Open Market Committee (FOMC) FAQs

What is the Federal Reserve?

The Federal Reserve is the central bank of the United States, and is generally considered to be the most powerful central bank in the world. Often referred to as the Fed, it was founded to direct monetary policy and manage the financial system. A seven-member board governs the Fed, and there are 12 Federal Reserve Banks in regions throughout the U.S.

What is the FOMC?

The Federal Open Market Committee (FOMC) is main policy making body of the Fed. The FOMC sets the federal funds target rate and makes other monetary policy decisions for the Fed. The FOMC meets eight times a year to vote on interest rates and policy priorities.

Who is on the FOMC?

There are 12 members of the FOMC:

  • The seven members of the Fed Board of Governors, led by Fed Chair Jerome Powell.
  • Five of the 12 Federal Reserve Bank presidents, although the head of the Federal Reserve Bank of New York is a permanent member of the FOMC. The other four voting positions are filled on a rotating basis by the presidents of the other Federal Reserve Banks across the country. Even though most presidents don’t vote, they can all attend the meetings and debate policy.

When is the next FOMC meeting?

The next FOMC meeting is scheduled for March 21-22, 2023. The FOMC hold eight scheduled meetings a year, one every every six weeks or so. The committee can also meet whenever it feels necessary and believes that it needs to act, such as during a financial crisis.

When are the FOMC minutes released?

The FOMC releases minutes of its meetings three weeks after the most recent meeting. A full transcript isn’t available for a full five years after a meeting.

How many times will the FOMC raise rates in 2023?

The FOMC has raised interest rates eight times since early 2022, putting the federal funds target rate at 4.50% and 4.75%. According to the CME FedWatch Tool, market professionals are betting that the FOMC will raise rates one more time in 2023.