Fed to Preserve Flexibility: Sep. 20, 2023 

With the Federal Reserve expected to skip an opportunity to raise the fed funds rate today, Chairman Jerome Powell is likely to strike a hawkish tone during his post-meeting press conference and emphasize that future rate hikes are still an option.  

Powell has previously likened the Fed’s current stage of the inflation battle to a car slowing as it reaches its destination. For Powell, who is a professed Grateful Dead fan, this could be the equivalent of driving slower after a highway exit while traveling to a concert knowing that a long portion of the road trip through winding local roads is still ahead. This long strange trip includes surprisingly persistent inflation, volatile commodity prices, a resilient economy and continued tightness in the labor market despite the Fed having already raised the fed funds rate 525 basis points (bps). Meanwhile, additional energy inflation pressures are possible with Saudi Arabia and Russia extending oil production cuts until the end of the year and the potential for labor union actions to sustain wage pressures, especially with the ongoing United Auto Workers strike that is targeting the Big Three automakers.  

While investors have previously downplayed Powell’s hawkish statements, they are onboard with his previous comments about taking a patient approach to fighting inflation and the need for the Fed to assess the impact upon the economy of previous rate hikes. The market is pricing a 99% chance that the fed will leave rates unchanged today. Meanwhile, market players have set a 28.9% probability of a 25-bp hike at the November meeting.  

As the Fed strives to avoid making comments that could be misconstrued as a commitment to future changes in its fed funds rate and balance sheet while providing investors with guidance on the economy, small revisions to the Federal Open Market Committee’s statement can be insightful, and in this case, the potential edits may imply that the central bank believes that economic growth is strengthening and/or inflation risks are softening. For this meeting it’s possible that the committee may make the following modifications of its July statement: 

• Change “moderate” to “strong” in the sentence: “Recent indicators suggest that economic activity has been expanding at a moderate pace.”  
• Change “remains elevated” to “is slowly cooling” in the sentence: “Inflation remains elevated.” 
• Remove “highly” from the sentence: “The Committee remains highly attentive to inflation risks.”   
• Remove “additional” in the sentence: “In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” 

The Summary of Economic Projections is likely to be today’s highlight alongside Powell’s remarks. I’m expecting heightened alterations to the median forecasts for gross domestic product, inflation and the federal funds rate. Robust consumer spending and elevated fiscal spending have driven stronger economic growth while supporting inflation. The primary shock to inflation more recently, however, has been commodities, with oil prices jumping for four consecutive months. Indeed, crude oil has led to pain at the pump for consumers, rising from a year-to-date low of $63.61 per barrel in May to a high of $92.62 just yesterday. Sturdy consumption, stimulative fiscal spending, persistent services inflation and hot commodity prices are likely to lead to higher forecasts for the federal funds rate in 2024 and 2025 while leaving 2023 unchanged at 5.6%. While signaling one more rate hike in November through the central bank’s dot plot, the outlook for the federal funds rate in 2024 and 2025 will likely be raised from 4.6% and 3.4% to 4.9% and 3.9%. Projections for core PCE inflation are likely to be upwardly adjusted from 2.6% in 2024 to 2.9% while leaving 2025 unchanged at 2.2%, marking it as the year the Fed potentially reaches its 2% inflation target. 

Markets Off to a Sluggish Start 

Markets are quiet ahead of Powell with the action likely to come later on. In the meantime, equities are up slightly while bond yields have declined at the margins, partly due to better-than-expected inflation data out of London. The small-cap Russel 2000 Index is leading the pack, rising 0.5%. The Dow jones Industrial and S&P 500 indices are up 0.5% and 0.1% while the Nasdaq Composite is down 0.2%. Internal breadth is strong, with all sectors higher except technology and communication services. Yields and the dollar are lower, with the 2- and 10-year maturities down 3 bps each to 5.07% and 4.33% while the Dollar Index is down 38 bps to 104.81. The greenback is depreciating relative to the euro, pound sterling, franc, yuan, yen and Canadian and Aussie dollars. WTI crude oil is giving up some of its recent gains, declining 0.2% to $90.35 per barrel.  

Fed to Remain Flexible in Fighting Inflation 

The Fed is likely to preserve its flexibility this afternoon. By maintaining a firm stance against inflation while leaving the door open for more rate hikes, the central bank anchors financial conditions. The messaging helps in subduing inflationary pressures. Doing the opposite by shifting toward an accommodative stance and pointing out the committee’s accomplishments will likely loosen financial conditions, risking a renewed acceleration in price increases.  

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