As expected, Fed raises interest rates by 75 basis points after today’s FOMC meeting. This will lift the benchmark federal-funds rate to a range between 2.25% and 2.5%. The rate increase won unanimous backing from the 12-member rate-setting committee. I feel it’s appropriate to paste the entire policy statement from the Fed officials here as it’s quite informative on which directions they are going.
“Recent indicators of spending and production have softened. Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.
Russia's war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2-1/2 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.”
We all know that Fed is very concerned about inflation and plans to raise rates higher to contain inflation. Though among the investment community, there’s already talk that Fed is going to raise the rates to ~3% by the end of this year and then starts cutting rates next year, according to this WSJ article. The treasury yields are currently progressively lower moving from one-year bills to 10-year notes as illustrated above. This inverted yield curve is usually indicative of a recession. The hope is that through the rapid rate increases, the Fed would quickly induce a recession to tame the inflation and they can start cutting the rates back once the inflation is under control. From the same WSJ article, the projection is that the rate would be cut to 2.5% level in June 2024 (instead of 0%). Chances are the 0% interest rate environment would be gone for a while until the inflation pressure is no longer a concern.
Overall, I feel it’s kind of bold for people to predict rate cuts in 2023 right now. There are so many known unknowns such as new COVID variants, the 20th Party Congress in China, the winter gas supply from Russia to Europe, etc. Not to mention there are also unknown unknowns. Around the same time last year, one of the Fed officials said they probably would start raising rates in early 2023. Given where we are right now, I will take these predictions with a grain of salt. I am definitely not making any hasty investment decisions based on these predictions.
I'm personally concerned about the wage inflation spiral.
Wage hikes are very sticky. They raise the base cost floor on everything.
Job openings to unemployed ratios are still at historic highs.
Anecdotally, in Canada our health care system seems to be breaking as support workers (nurses and technicians) leave for better paying less stressful jobs. Fastfood restaurants operate on reduced hours for lack of staff as service industry employees went to white collar/admin/trade jobs.
There needs to be enough layoffs to move people out of unnecessary/discretionary rolls back into necessary rolls. Recessions generally tend to drive labour efficiency which also seems to be desperately needed.
While I do think we get a housing market correction with rates and these levels, I'm not sure that it is enough. Savings levels are very elevated. While discretionary spending is slowing, people can dip into their savings for some time to cover the wage/inflation delta.
All this rambling to say, like you, I think rates need to go much higher than the market currently has priced in before we can get to easing.