The Fed downshifted to a smaller rate hike to start 2023, but the job is far from done. As expected, the Fed raised rates by 25 basis points (bp) today, slowing from the 50bp hike in December, and the 75bp hikes at the four meetings before that. However, the Fed continued to reiterate that ongoing tightening is warranted and repeated the view that the risk to doing too little is greater than the risk of doing too much.
While we have to wait for March to get updated forecasts from the Fed (the dot plots), there were a number of changes to the Fed statement and Powell had plenty to talk about during his press conference.
If you only saw today’s statement announcing the Fed’s move, the primary takeaway would be a shift toward a more dovish tone. Instead of focusing on the factors causing inflation to stay elevated, the Fed introduced new text that inflation pressures have started to ease. And gone is commentary about the ongoing Russian/Ukraine conflict contributing to inflationary pressures, which is now replaced with a note that the conflict is keeping global uncertainty elevated. Finally, with the size of today’s rate hike down to 25bp, text was changed to shift the attention from the pace of hikes to the extent of future hikes. In other words, the Fed’s focus is now on finding the finish line.
Then the press conference started. Chair Powell started dovish stating that it is “gratifying” to see disinflation starting to show in the data, and acknowledging that softening in wage pressures is a positive sign for future inflation, but he then tempered those remarks by reinforcing his belief that there is more work to be done. What has the Fed concerned is that non-housing service inflation remains unusually high. Until this metric turns, the Fed will not feel comfortable claiming victory and backing off.
Nick Timiraos – the Wall Street Journal’s Fed reporter who many watch as an unofficial mouthpiece for Powell and Co. – asked the question that many have been thinking. Can the Fed simply pause at the current level of rates and watch to see how that flows through to inflation prints in the months ahead? Powell responded by saying the Fed thinks the greatest risk – and the most difficult situation for the Fed to manage – is in not doing enough and seeing inflation reaccelerate. If the Fed overshoots on tightening and inflation comes down faster and further than anticipated, the Fed has far more tools available to ease policy. Victory over inflation is priority #1.
It’s good the Fed has prioritized the fight against inflation, but the necessary path to get there will likely bring volatility to the financial markets. While markets have rallied to start the year, we expect the party to end once they realize how much the economy will slow due to the decline in the M2 measure of the money supply since early last year. That economic medicine, while bitter, is part of the price we pay for the policy mistakes in 2020-21. And we are still amazed at how little attention the Fed and journalists give the money supply.
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
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