The Fed’s Decision Is As Expected

The Fed’s Decision Is As Expected


What Happened?  

As expected, the Federal Open Market Committee raised its benchmark interest rate by 0.75% to a range of 2.25%–2.50%. The policy rate is now at the lower end of the range the Fed believes is “neutral”—the rate that neither stimulates nor constrains the US economy. As it relates to future hikes, Chair Powell said that another “unusually large” rate hike is a possibility, but he also made clear that such a decision has not yet been made. That’s a difference in tone from the past couple of meetings at which the Fed strongly hinted at 75 b.p. increases. The market took Chair Powell’s comments, in entirety, as dovish—stocks rallied and interest rates fell.

Where To from Here?  

To be clear, further rate hikes remain very likely, but the magnitude of each will depend on incoming information. What information? The labor market and inflation. The Fed is sticking to its knitting here—the dual mandate is full employment and price stability. Unless or until either the labor market weakens or inflation comes down convincingly, the Fed is likely to continue raising rates. Either a hike of 0.25% or 0.50% is the most likely outcome for September, depending on what the next couple of payrolls reports and inflation prints show.

The Market’s View vs. the Fed’s View

The market’s view of the economic outlook appears to be significantly darker than the Fed’s—the Fed continues to believe that a soft landing is possible and indeed likely, while the market appears to believe that it is all but impossible. Our own view is somewhere in the middle. We expect the economy to slow into 2023, with GSP growth next year at ~1% (down from ~3% in 2022 and 6% in 2021). And while we may (or may not) avoid a recession, the final determination is moot since it will feel like a recession to many in the US economy. 

As a result of the chasm between the market view and the Fed view, there is a massive gap between market pricing of the future rate path and the Fed’s own expectations. The Fed expects to be raising rates through year-end and into 2023, while the market is now priced for a terminal rate well below the Fed’s expectation and for multiple rate cuts next year. We will get updated Fed dot plots in September, which will be an opportunity to see if the incoming data has narrowed the gap. 

In the meantime, we expect volatility to increase around the incoming data. The more data dependent the Fed is, the more important each data point will be—especially labor market and inflation data.


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GE-4877975.1 (08/22) (exp.08/24) 

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