Credit Agricole

A second 75bp hike to curb inflation

As widely expected, the Fed delivered a second 75bp rate hike in its fight against four-decade high inflation prints, taking the policy rate to 2.25-2.50% in a unanimous vote. FOMC officials remain “highly attentive” to inflation risks, maintaining a laser focus on returning inflation back to target.

Looking ahead, the statement offered unchanged guidance stating that the “FOMC “anticipates that ongoing increases in the target range will be appropriate”, which clearly signals that more tightening is on the way, though leaves the Fed’s options open by not committing to any specific path.

Chair Jerome Powell followed this up by suggesting at his press conference that another unusually large rate increase would depend on incoming data, but it would be appropriate to slow the pace of hikes at some point. Powell reiterated that the FOMC is looking for “compelling evidence” of inflation moving down.

However, given significantly higher uncertainty than usual, Powell also noted that the Fed will offer “less clear guidance” on future rate decisions, which will be made on a meeting-by-meeting basis depending on the data. This makes sense to us as the Fed would prefer to avoid another situation like the June meeting, when Committee members had explicitly signalled a preference for a 50bp hike before switching to 75bp at the last minute. As a result, the Fed will continue to offer guidance, though will stress data dependence and avoid committing to a specific path.

That said, Powell did note that the Fed sees “significant additional tightening” in the pipeline as rates move to a “moderately restrictive” stance by the end of the year. While he was clear that it will be updated at the following meeting and should not be taken as set in stone, he pointed to the latest dot plot as a rough guide, which shows rates hitting a 3.25-3.50% target range by yearend and modest additional tightening in 2023.

The market pricing of the terminal policy rate has evolved over the past couple of months, from as high as 4.00% to the latest 3.30%, as the market has transitioned from inflation fears to recession angst. Additionally, the market sees the Fed cutting rates in 2023, potentially as soon as March, with rates dipping below 3% by yearend.

We currently see the Fed raising rates to3.50-3.75% by yearend 2022, with a 50bp hike at the upcoming September meeting, though another 75bp move remains a risk. That said, we are less convinced that the Fed will cut in 2023 and instead see it remaining on hold despite softening data as it continues to place a higher weight on the inflation side of the mandate.

In its statement, the FOMC acknowledged a slowdown in the economy, highlightingsofteningspendingandproduction,butnotedthatthelabour market has remained robust. Inflation has stayed high, due to Covid-related supply/demand imbalances plus higher energy prices and broader price pressures.