Keeping with market expectations, The Federal Open Market Committee (FOMC) raised the target range for the federal funds rate by ½ percentage point, bringing the target range to 4 ¼ to 4 ½ percent. While the increase broke a string of four straight ¾ point hikes, the Federal Reserve has raised interest rates by 4 ¼ percentage points this year and anticipates further restrictive action next year, indicating the fight against inflation isn’t over.   

However, the FOMC did acknowledge the U.S. economy has slowed significantly from last year’s rapid pace, as growth in consumer spending has slowed, activity in the housing sector has weakened, and signs in business fixed investment has deteriorated. The committee’s projection for real GDP growth stands at just 0.5 percent this year and next, well below longer-run normal growth rates.   

Although October and November show welcome relief in the monthly pace of price increases, it will take substantially more evidence for the Federal Reserve to have confidence that inflation is on a sustained downward path. In November, the 12-month change in the Consumer Price Index (CPI) was 7.1%, and the change in core-CPI (ex-food and energy) was 6%. Inflation remains well above the Federal Reserve’s stated mandate and target of 2%.   

The Federal Reserve’s preferred inflation measure is the Personal Consumption Expenditures index or Core-PCE which tracks goods, housing services, and non-housing related core services. During Chair Powell’s press conference, he acknowledged supply chains are being resolved, have improved, and we have started to see goods inflation come down. As rents expire they will be renewed into a market where lease rates are higher than original leases, however the rate for new leases is coming down. Once we work through the rent backlog, housing services inflation will also come down, sometime next year. The third piece, which is the largest inflationary percentage, approximately 55%, is non-housing related core services. This sector is really a function of the labor market and the biggest cost by far is labor. Because of the strength of the labor market, there is an expectation from the Federal Reserve that services inflation will not move down so quickly. Despite the slowdown in GDP growth, the Fed sees a strong labor market, with the unemployment rate near 50-year lows. Job vacancies and wage growth remain elevated as an out of balance labor market continues with demand substantially exceeding the supply of available workers.   

Looking back to the beginning of the year, from Fed lift-off to a restrictive 4.25% policy, the pace or speed of interest rate hikes was an important accomplishment of the Federal Reserve. As we enter 2023, the pace of rate hikes becomes less important, rather how far (the committee is projecting 5.1%), and then how long does the Federal Reserve remain restrictive.      

Disclosures 

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