The FOMC meeting: Rates have to rise further but perhaps more slowly

At its meeting on 2 November, the Fed raised rates by 75 bps. Chairman Powell indicated that the Fed may raise interest rates several more times, but also that those increases may come at a slower pace. In addition, he signalled that the ultimate level of the policy rate will be higher than previously expected, that is, higher than the September FOMC median projections of 4.4% in 2022 and 4.6% in 2023.

Powell presented Fed policy as resulting from a balance between two forces.

The first of these is the policy tightening already implemented this year; the Fed has raised rates by 3.75% in the seven months since March. Since the Fed normally raises interest rates by about 20 basis points per month in a tightening cycle, that is a very large and rapid tightening of policy. With so much cumulative tightening yet to be felt, rate increases could slow at a future date.

But core inflation has failed to slow and labour markets remained exceptionally tight, which point to a need for further interest rate increases. As Powell put it, the Fed has “more ground to cover”.

In judging these factors, Powell emphasized that the Fed views the consequences of doing “too little” as much more damaging than the consequences of doing “too much.” In the former case, interest rates would have to be maintained at a high level for some considerable period, whereas in the latter case the Fed could quickly adopt a more expansionary policy stance. The risks to the expected path of interest rates are thus to the upside. While Powell said that a discussion of slowing rate increases is still “very premature”, he implied that the discussion within the FOMC has shifted from the view that interest rates are far too low and that the Fed should raise them rapidly, to a discussion of how far they should be increased. The Fed is plainly approaching the likely “peak” level of interest rates, although exactly where that level is remains uncertain.

Powell also signaled that the Fed may start slowing the speed of increases as early as the meeting on 14 December, by when it will have access to both the October and November CPI inflation data, released on 10 November and 13 December respectively.

If core inflation were to moderate in those two months, the Fed may well decide to raise interest rates only by 50 bps. And if it doesn’t and labour markets remain tight, a 75 bps increase is likely. The CME FedWatch Tool shows that market participants think a 50 bps increase is a little more likely than a 75 bps increase.

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