Fed Hikes Rates to 16-Year High, but Hints at Pause

Key Points

• As expected, the Federal Open Market Committee (FOMC) increased the federal funds target rate to a range of 5% to 5.25%, a 0.25% increase.
• This marked the 10^th consecutive rate increase in the current hiking cycle and brought rates to a 16-year high.
• Fed officials hinted that there could be a possible pause in rate hikes.

At their May meeting, Federal Open Market Committee (FOMC) members agreed to hike the fed funds rate by 0.25%, which was in line with market expectations. The latest hike raised the benchmark rate to a range of 5% to 5.25%.

With the raise, the Fed signaled that a pause may be nearing, stating, “In determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” But the committee did not close the door on future rate hikes. “Looking ahead, we’ll take a data-dependent approach in determining the extent to which additional policy firming may be appropriate,” Federal Reserve Chair Jerome Powell said. He added that “a decision on a pause was not made today … we’ll approach that question at the June meeting.”

The rate hike and messaging about a potential pause continued to highlight the committee’s vow todo what is necessary to tame inflation, while also remaining transparent about the committee’s path to keep markets informed.

Overall, economic activity continued to increase in the first quarter, though at a slower pace than the fourth quarter of 2022, with GDP growing a modest 1.1% quarter-over-quarter. The monthly Personal Consumption Expenditures (PCE) estimates, however, showed that spending growth was front-loaded, with purchases surging in January and falling off in February and March. This pattern could be a sign of a gradual slowdown that could carry through to the second quarter, which may be a sign that the Fed’s 10 consecutive rate hikes are finally impacting the economy.

While GDP growth may slow into contractionary territory in the second quarter, this may actually be welcomed by the FOMC, as its intent to slow demand and bring inflation within range of the 2% long-term target may be closer in view than what they had initially predicted in March.

Below are the Fed statement language changes from March:

Market Reaction

After the Fed announcement, the 10-year Treasury ended the day lower and finished at3.38%; short and long rates were also lower for the day.

Markets closed in negative territory on the final day of the FOMC meeting. Both the Dow Jones Industrial Average and S&P 500 Index moved lower (-0.80% and -0.70%,respectively) during Chair Powell’s press conference. Treasury yields on both the long and front end moved lower as the 10-year and 2-year Treasury spread decreased to -0.51%.

In Conclusion

This meeting did not check all of the boxes investors were looking for from the Fed, as it was a keen reminder that the Fed’s 2% inflation target is likely still a ways out. The slow progress in the inflation battle continues to underscore the Fed’s emphasis on slowing economic activity and cooling the labor market. While the monthly core PCE inflation print has steadily decreased, it remains well above the FOMC’s median projection for the fourth quarter of 2023 and may warrant the Fed waiting one more meeting before they take a pause in hiking rates.

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