What is Jerome Powell, Chair of the Federal Reserve, Saying to the Market?

The macro regime is projected to undergo a recession with an ambiguous duration and severity in early 2023, following the stagflation of 2022.

There was a hawkish tone to the FOMC meeting, going into Chair Powell’s press conference.

Through Madhavi Arora

The Fed unanimously decided to increase rates by 50 bps, as was generally anticipated, but it did so with a hawkish posture with the caveat that "more work remains." The hawkish tenor of the policy statement was set by:

(1) Upward revisions to the dot plot, in particular a 50 bp increase in the median for 2023 with a highly skewed distribution, with 17 out of 19 FOMC members voting for a peak of 5.125% and many members opting for higher peaks of 5.5 to 5.75%. The 2024 dots showed a far broader range of uncertainty, although the median end-2024 price increased by 25bps to 4.125% (representing a 100bps reduction from '23).

(2) A stronger inflation profile over the following two years, and

(3) Continued use of the phrase "ongoing" rate hikes in the announcement.

All of these lent the FOMC meeting a hawkish tenor before Chair Powell's press conference. In his press conference, Chair Powell maintained that tone by repeatedly emphasizing that "it will require significantly more evidence" to establish confidence that inflation is on a persistent downward trajectory. This suggests that any cycle stop is still likely to be several meetings away.

He often referred to the imbalance in the labor market and added a clear note of caution while cheering the most recent downward CPI surprise. The possibility of downshifting to 25bp hikes starting with the next meeting in early February, however, seems to be left on the table.

According to updated economic projections, there will be typically less growth, increased unemployment, and higher inflation. The projected GDP for 2023 was reduced by 70 basis points to 0.5%. In 2022–2024, the projection for the core PCE inflation trend was raised, and it stayed over the 2% target for the duration of the projected period.

The upward revision of inflation appears to reflect the anticipated continuation of this year's inflation into the following. Powell described this as still solid even though the projected unemployment rate for next year is 4.6%, which is almost a full point higher than the current rate.

Although Powell firmly suggested that the next move in February could be 25 bp and provided his opinion that a soft landing is still possible, the market's response was muted online.

For the first time this year, the indicated terminal rate represented by the dots has risen far above the terminal's current market price (by a little over 25bp).

Also Read: Fed rate hike may set US stocks for a mega bull run in 2023 and beyond

Even while Powell warned that a "very, very robust" labor market risks non-shelter core services inflation (55% of core PCE) continuing persistently elevated far into next year, the markets also seem to be interpreting the cooling in the Oct. and Nov. CPI readings as a positive signal. He essentially compared this aspect of inflation to a labor market function.

Since the beginning of the year, we have issued warnings against having any expectations of a straight line of disinflation. Fed confirms that once more.

The Committee will likely increase rates by up to 75 basis points in 1QCY23, but there is a chance that the labor market won't have abated enough by that time to allow for a halt. We predict that the real terminal rate will be higher than trend growth, typically followed by recessions. Thus, depending on the magnitude of sacrifice ratios, it will be difficult to predict whether the rate will reverse by the end of 2023 or in 2024.

The macro regime is anticipated to follow the 2022 stagflation in the early months of 2023, entering an undetermined length and depth of recession while sacrificing respectable growth to control the inflation imbalance. Investors therefore require high-risk premia, of which there is now no evidence, in order to hold any cyclical risk asset.