The Federal Reserve unanimously voted to raise rates by three-quarters of a percentage point - 75 basis points (bps) - today, bringing the target for the federal funds rate to 2.25 – 2.50%, and signaled expectations for continued hikes in the months ahead. While today’s meeting was not accompanied by updated forecasts from the Fed (the infamous dot plots), there were some notable comments on how Powell and Co. view the current outlook.
Starting with the Fed statement, there was a softening of language around economic activity. Should this be considered a sign that the Fed believes the economy is in (or on the verge of) a recession? Not so fast. Powell explicitly stated during his press conference that he “does not think the U.S. is currently in a recession.” Why? Performance is simply too strong in too many areas. Employment is robust, the unemployment rate stands near a 50-year low, and industrial production continues to expand. So while tomorrow’s GDP release may show a negative print for a second consecutive quarter – the rule of thumb definition of a recession but not the official determinant – Powell is taking the release with a grain of salt. Given the tendency for GDP reports to be revised as more/better data is collected, we wouldn’t put much weight on tomorrow’s data either.
Our biggest concern over today’s Fed activities has nothing to do with what they published or said, but rather what they continue to ignore. The M2 money supply is and has been the biggest factor on inflation, yet Powell and the committee statement didn’t mention it once, nor did any reporter ask a question on the topic. While the Fed meets again in late September, we care far more about the next release of M2 data on August 23rd. Thankfully, M2 growth has moderated through the first half of 2022, up at a modest 1.7% annual rate after double digit increases to start both 2020 and 2021, but the fact that the Fed hasn’t made a slowdown in M2 growth their top priority heightens the risk that their tightening of monetary policy misses the mark and they continue to battle from behind the curve.
The bottom line is that it’s good the Fed has prioritized the fight against inflation, but it remains overly optimistic in how quickly it will get inflation back under control, especially as they use a drill to hammer a nail. We expect a continuation of rate hikes through the remainder of this year, even if that pace moderates. The market is pricing in rate cuts early in 2023. Without clear signs of recession, that’s unlikely to happen.
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