- As expected, the Fed raised interest rates by +25 bps to a range of 5.25%-5.50%
- The Fed is nearing the end of its hiking cycle; Key question now is duration of time the Fed will keep rates elevated at the current level
- We think the debate over September is less relevant than the duration at which the Fed will hold rates higher
- Higher for longer is our base case
As expected, the Fed hiked the Fed funds rate by +25 bps, to a range of 5.25-5.50%. This was a resumption in the tightening cycle, after the Federal Open Market Committee (FOMC) paused at the June meeting. The increase was fully expected, and priced in, by markets. In our view, the Fed hiked again this week because financial conditions remain relatively easy, and inflation, while declining, remains above target. In the press conference, Fed Chair Powell noted that the Fed “has covered a lot of ground,” but has more work to do. In response to a question, he said that monetary policy has “not been restrictive enough, for long enough” to have the desired impact.
The focus now turns to the question of whether this was the last rate hike of this cycle, and how long interest rates will stay elevated. Key questions:
- Will the Fed hike again?
- How long will the Fed hold rates at this level?
In justifying its decision to resume hiking at this meeting, the FOMC statement emphasized that the economy remains healthy and inflation, while declining, is not yet back to its 2% target: “The Committee seeks to achieve maximum employment and inflation at the rate of 2% over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 5-1/4 to 5-1/2%. The Committee will continue to assess additional information and its implications for monetary policy.”
As a reminder, this cycle has been exceptional for its quick pace of hikes, as shown in the chart below:
Inflation Still Coming Down
Inflation Still Coming Down
The key issue for the Fed remains inflation. On that front, there has been continued good news. CPI on a year-over-year basis continues to decline. As of June 2023, headline CPI fell to only 3.0% from a high of 9.1% in June 2022. As can be seen below, the Fed typically does not stop hiking rates until real rates turn positive: that is, Fed funds rate (orange line) is higher than CPI (gray line):
After clearly lagging behind in this cycle, the Fed funds rate is now definitely above the CPI rate. They are now in restrictive territory. However, we highlight the following:
- Core CPI, which excludes volatile food and energy prices, is now higher than headline CPI. The last print for core CPI was 4.8%. The core PCE, which is the Fed’s preferred inflation metric, was 4.6% in June.
- In order to average 2% inflation over time, at some point inflation would need to go below 2% for some period of that time. It seems very unlikely for inflation to dip below 2% in the foreseeable future, thereby leaving the glide path to an average 2% inflation rate elusive.
- The path down to 2% inflation from 3% remains challenging. If the month-over-month inflation numbers even stay on a current path of 0.1%-0.2%, we estimate that core CPI will be down only to 3% by January 2024, as base effects from last year start to flow out of the YoY inflation comparables, as seen in our estimated graph below.
We note that the Fed has usually held rates above CPI for an extended period of time in past tightening cycles, and we remain concerned that the Fed does not yet have enough visibility to get the U.S. economy back to 2% inflation. Indeed, Fed Chair Powell noted that the most recent Summary of Economic Projections shows the core CPE will not get all the way back to 2% until 2025. That means that there could be more work to do, and the July rate hike may not be the very last of this cycle.
Amerant View
But, in our view, it really doesn’t matter: even if July’s hike was the last one of this cycle, we expect that the Fed is likely on hold for an extended period of time. In short, the debate over whether the Fed will hike at the September meeting is somewhat beside the point. It is clear that the Fed has finally gotten monetary policy into restrictive territory, after its “transitory” stumble on inflation earlier in this cycle. Whether it does one more hike for emphasis, or leaves rates on hold from her on out, is not the key issue. Rather, we believe that the duration of the Fed’s restrictive stance is the key factor which markets need to evaluate. Given the Fed does not expect core PCE to reach 2% until 2025, we believe rates will likely be held at a restrictive level for the better part of 2024. We expect the economy will continue slow in this higher for longer regime.
