Posted February 3, 2023

Interest rate watch: Wells Fargo comments on latest hike

From the Economics Group of Wells Fargo Bank, N.A.: The Federal Open Market Committee (FOMC) elected to raise the federal funds rate by 25 bps at the conclusion of its monetary policy meeting on Wednesday. This action lifted the range of the federal funds rate to 4.50%–4.75%, which is 450 bps higher than it was when the FOMC first started its tightening cycle last March.

The outcome was largely anticipated, with little surprise coming from the statement or post-meeting press conference.

Chair Powell acknowledged that the disinflationary process has started, but continued to emphasize the Committee's job is not yet done. Powell explicitly stated, "We have more work to do" and it's "very premature to declare victory" when it comes to inflation. In regard to further tightening, the statement noted "the Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time."

This sentence is a clear indication that further tightening lies ahead, but how much remains uncertain.

Our base case expectation continues to be for the FOMC to hike the federal funds rate by 25 bps at each of its next two policy meetings on March 22 and May 2, which would bring the target range for the federal funds rate to 5.00%-5.25%. That said, the Committee is in the fine-tuning stage of its tightening cycle, and the number of remaining rate hikes will depend on incoming economic data in coming weeks and months.

While the end of the FOMC's tightening cycle may be pulling into sight, we believe there is a long way to go before the Committee begins to ease policy. We do not look for rate cuts to begin until early 2024.

This view continues to differ from market expectations. Stock and bond markets rallied following the FOMC's decision on Wednesday, which was likely in response to Chair Powell acknowledging disinflation has started without a significant deterioration in the labor market.

The January jobs report then surprised to the upside on Friday morning, signaling employers added a whopping 517K workers during the month. This report demonstrates the labor market is still too hot, and fed futures came up slightly on the news, pricing in a 90% chance of a 25 bps rate hike in March in light of the jobs report. That said, market pricing still implies the federal funds rate will peak in June and finish the year around an upper-bound of 4.65%.

When questioned about this divergence – between Fed forecasts and market projections – at the post-meeting press conference Chair Powell attributed it to markets' expectation that inflation will move down more quickly. He also went on to say, "I don't see cutting rates this year if our outlook turns true."

Recall, as of the December Summary of Economic Projections, the Fed's median projection for inflation was for the core PCE deflator to average an annual rate of 3.5% in the fourth quarter of this year. Ultimately, the Fed wants to ensure inflation is truly making its way back to target before it eases policy. The latest jobs data suggest it has more work to do.