FOMC Minutes Preview: About That Terminal Rate

Submitted by Newsquawk

SUMMARY: The minutes will be gauged to see the discussion around the dot plots from the September meeting and any arguments officials made and at what point the terminal rate should be reached in 2023. However, SGH Macro’s Tim Duy suggests “at some point the data needs to cooperate before the Fed can have any real confidence that the terminal rate is in sight”. We will also be eyeing any commentary within the minutes that suggests how long rates should be held at terminal for, and what conditions would ensue such a pause or even a future rate cut – but the tone of recent Fed language has suggested more hikes until inflation is confidently on its way back down to 2%, with officials pushing back on the idea of a pivot any time soon given their commitment to bringing inflation down. Note, Fed’s Bostic recently said he does not expect the Fed to continue hiking until inflation is at 2% as, due to policy lags, it would result in over tightening – implying a pause before inflation reaches target. Talk of a Fed pivot has increased heavily in recent weeks and given the minutes are an account of the September 20-21st meeting, it will not be incorporated into the latest release, nor will the September jobs report.

PRIOR MEETING: The FOMC hiked rates by 75bps to 3.00-3.25% in September, in line with the consensus expectation. The statement was largely unchanged from the July meeting, noting that “the Committee… anticipates that ongoing increases in the target range will be appropriate.” That left the focus on the updated economic projections, which were judged as hawkish: officials now see rates at 4.25-4.50% by end-2022 (previously 3.25-3.50%); officials also raised their view of the terminal rate (now see the FFR range peaking out between 4.50-4.75% in 2023 vs previous forecast of 3.75-4.00%); after 2023, the Fed expects rates will decline to 3.25-4.00% by the end of 2024, and then fall to 2.75-3.00% in 2025; it left its estimate of the neutral rate unchanged at 2.5%. Inflation projections were unsurprisingly lifted, and the central bank does not expect headline PCE to be at target before 2025; growth projections were slashed, and at least one official sees a contraction in 2023.

POWELL: Chair Powell’s press conference was underwhelming by comparison, and he revealed little by way of fresh insight, affirming many of the points he made at the recent Jackson Hole Economic Symposium. Powell once again caveated the dot plots, stating that it does not represent a plan or commitment from the Fed. The Fed chief was asked about the conditions that officials would need to see before endorsing arguments for lower rates, and repeated that there would have to be a confidence that inflation is moving back down to 2%. In wake of the meeting, one point analysts picked up on is the divergence of views on the Fed over how far it needs to get into restrictive territory, and Powell danced around that, saying the Fed has now moved to the “very lowest” level of what it considers restrictive, saying there is still a ways to go on rates, without giving specifics about where he sees the terminal level, aside from his comment that the Fed would likely get to levels in the Dot Plot.

PIVOT: There has been a lot of talk in recent weeks about a potential Fed pivot, although it is worth noting the Fed minutes are an account of that particular meeting, they do not factor in commentary or developments that followed in wake of the FOMC. As such, while many desks will be keeping a close eye on them for any remarks that suggest the Fed would be prepared to halt the course of its policy normalization if it triggered an unnecessary US recession or financial stability risks, the minutes may not feature some of the more recent thinking of officials. Many Fed officials have acknowledged the risks abroad regarding financial stability, such as the UK gilt market, Credit Suisse woes, and a Eurozone economic slowdown, while a smaller than expected hike from the RBA also led to increased calls that the Fed could do the same. However, they have, overall, sounded rather dismissive of a “pivot” resulting in a change of policy, stressing their mandate is a domestic one, inflation is too high, the bar for a change in policy is very high, while the risks of tightening too much are not as bad as doing too little.

OUTLOOK: Market pricing for the terminal rate has been choppy in recent weeks, but currently sits above the Fed’s median of 4.6% which implies an FFR of 4.50-4.75%. The latest push higher came after the September jobs report and hawkish Fed commentary pushing back on a pivot, and markets now imply a terminal rate of 4.7%. Meanwhile, for the November meeting, markets have been leaning towards a 75bp hike over 50bp, with the latest pricing at an over 90% probability. Goldman Sachs said the updated dot plot suggests that the Fed would hike rates by 75bps again at its November meeting, followed by a 50bps rate rise in December, and then a 25bps hike in January. For 2023, GS says that the path of rates will depend on how quickly growth, hiring and inflation slow, and whether the FOMC will really be satisfied with a sufficiently high level of the funds rate and willing to slow or stop tightening while inflation is still uncomfortably high