Inflation Remains Fed's No. 1 Concern

Key Points

• As expected, the Federal Open Market Committee (FOMC) unanimously voted to increase the federal funds target rate range to 4.75% to 5%, a 0.25% increase.
• Median projections from committee members showed one more potential hike in 2023. As for potential rate cuts, expectations are for four each in 2024 and 2025.
• Inflation projections showed slight increases for 2023 (from 3.5% to 3.6%) and 2024 (from 2.5% to 2.6%).
• The Fed’s economic outlook called for a minor downtick in GDP for 2023 with a material decrease in 2024 projections from December estimates (from 1.6% to 1.2%). Unemployment projections for 2023 moved lower from 4.6% in December to 4.5%.

At their March meeting, Federal Open Market Committee (FOMC) members agreed to hike the fed funds rate by 0.25%. The latest hike raised the benchmark rate to a range of 4.75% to 5%, an increase that met market expectations.

Despite an unfolding banking crisis, the rate hike continued to highlight the committee’s vow to do what is necessary to tame inflation in an economy that has defied many economists’ predictions of an imminent slowdown. While Fed officials over the past year have acknowledged the risk of simultaneously combatting two problems—inflation and financial instability—several members have said they were prepared, if needed, to use emergency lending tools to stabilize markets, which would allow them to continue increasing interest rates to tame inflation while maintaining market stability.

The Fed slightly lowered estimates for GDP growth in 2023 from 0.5% to 0.4%, which sits well below the committee’s long-term (beyond 2025) estimate of 1.8%. The Fed increased inflation estimates for this year from 3.5% to 3.6%. Unemployment rate projections for 2023 decreased from 4.6% to 4.5% but remained unchanged for 2024 at 4.6%.  

Below are the Fed statement language changes from February:

Here are the committee’s March projections for GDP, unemployment, inflation, and the federal funds rate for 2023 through 2025 from the Summary of Economic Projections (SEP):

The committee’s “Dot Plot” contained no changes in projections for the fed funds rate in 2023 and 2024, and only a marginal increase in 2024. The Dot Plot showed 17 of 18 committee members expected the fed funds rate to finish 2023 above 5%, implying that markets should price in at least one more hike this year. However, 7 of the 18 members expect the benchmark rate to rise above 5.25% in 2023. As for rate cuts, the committee repeated its expectations for cuts to begin in 2024, with projections showing four potential 25-basis-point decreases in 2024 followed by four more cuts in 2025.

After the Fed announcement, the 10-year Treasury ended the day lower by 11 basis points at 3.48%; short and long rates were both lower and the 10-year/2-year Treasury spread finished the day at -0.48%.

10-Year Treasury Yield over the Past 12 Months

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 (-1.63% and -1.65%, respectively) during Chair Jerome 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 -0.48%.

In Conclusion

Investors were prepared for the Fed to continue down its rate-hiking path, extending what has been the fastest series of rate increases since the early 1980s. With recent data still pointing to strong wage and price pressures, the action taken by the Fed supported the case that raising rates by a quarter point was necessary, even given current credit issues. While the U.S. economy has remained resilient, the gradual effects of past rate hikes appear to have started to make their way through various sectors of the economy. If the Fed continues its historic rate hiking, the central bank’s aggressiveness may risk exacerbating market upheaval, a painful downturn, and more intervention. Going forward, markets will likely keep a close eye on whether the Fed’s focus begins to shift from inflation to market stability.

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