Fed Talk 12.13.23

• The recent ‘Dot Plot’ from the Federal Reserve reveals a median forecast for the 2024 Fed Funds rate at 4.6%, closely aligning with market expectations as reflected in the pre-announcement pricing of the 2-year note. This projection, part of the Federal Reserve’s Summary of Economic Projections (SEP), suggests that market participants’ belief in the 2-year note as a reliable indicator of the Fed Funds rate trajectory is well-founded. The ‘Dot Plot’ also indicates that the Federal Open Market Committee (FOMC) views current rates as nearing the peak of their tightening cycle.

• Jerome Powell, the Fed Chairman, emphasized a proactive approach to rate adjustments in response to a reporter’s question about rate cuts in relation to the 2% inflation target. Powell’s stance suggests a readiness to ease policy before inflation dips to 2%, highlighting a preference for pre-emptive action rather than reactionary measures. This approach is crucial, as lowering interest rates tends to be simpler than increasing them, both in theory and in practice.
  
  “The reason you wouldn’t wait until 2% inflation to cut rates is that policy would be too late.”
  

• Powell acknowledged that the current policy stance is restricting economic activity, a necessary step to manage inflation. However, recent economic indicators signal a slowdown, a concern echoed in the SEP’s projection of a modest 1.4% GDP growth and a rise in unemployment to 4.1% next year. Significantly, the SEP does not foresee further rate hikes, and in fact forecasts a reduction in rates ahead. This outlook has led to a positive market response, with long-term Treasury yields falling and the 10-year note dropping from its October peak of 5% to about 4.02%.

• In addressing wage inflation and its impact on overall inflation targets, Powell noted that current wage trends, though slightly higher than desired, are not excessively out of line with the 2% inflation goal over time. He also expressed confidence in the FOMC’s ability to balance the risks of over-tightening against those of being too lenient, indicating a focus on stabilizing prices while considering employment factors.

In summary, the SEP’s dovish Dot Plot has reinforced market expectations of looser monetary policy going forward. The market’s reaction, evident in rallying long-term yields and equities, reflects this sentiment. Despite the recent CORE CPI reading of 4.0% and fluctuations in oil prices, there’s a concern that the Fed might be prematurely celebrating its victory over inflation. The shift in the 10-year Treasury yield from 5.0% in mid-October to around 4.02% post-announcement marks a significant easing in credit conditions, yet the path to achieving the 2% inflation target remains uncertain.