More Fed Rates Hikes Are Coming

The press conference with Jay Powell and the Fed minutes have made it clear – no rate cuts in 2023.
The minutes also made it clear that more hikes may be coming.
The bond market has now removed all rate cuts in 2023 and is now pricing in more hikes.

If you were hoping for the Fed minutes to signal that rate cuts were coming, you were disappointed. The minutes revealed no sign that rate cuts would be coming, while the data-dependent approach Powell talked about on May 19 was repeated in the minutes, stressing the optionality of further rate hikes.

If you were in the camp that thinks the Fed is cutting rates, it seems pretty clear from the minutes that it’s not happening. If you were in the camp that believes the Fed has finished raising rates, that is likely not happening either. The Fed minutes noted right on page 3 that:

Responses to the Open Market Desk’s Survey of Primary Dealers and Survey of Market Participants suggest that investors’ macroeconomic outlooks were little changed from March despite ongoing focus on the implications of the expected tightening of credit.

The paragraph below notes:

Survey respondents assigned a much higher probability to the peak federal funds rate being between 5 and 5.25 percent than they did in March. However, respondents still assigned a substantial probability that the peak rate may turn out to be above 5.25 percent.

Additionally, it was noted on page 10 that:

Some participants stressed that it was crucial to communicate that the language in the post-meeting statement should not be interpreted as signaling either that decreases in the target range are likely this year or that further increases in the target range had been ruled out.

Powell reiterated this sentiment during the May 19 question and answer session, making it evident that rate cuts were not on the table, as the Summary of Economic Projections indicated. His emphasis on closely monitoring the data and making decisions on a meeting-by-meeting basis was clear. Additionally, he noted that rates might not need to rise as high as previously anticipated, which isn’t the same as saying the Fed is finished raising rates and implies that there may be a need for further rate increases.

If the Fed had intended to stop rate hikes, it had ample opportunities to convey that message between the May meeting and the release of the Fed minutes. However, the message conveyed has been quite the opposite.

The market has noted this, and as of May 25, the Fed Fund Futures have largely eliminated the possibility of rate cuts in 2023. The December Fed Fund Futures are currently trading at 5%, and there is now a 94% probability priced in for another rate hike to occur between now and July.

Powell and the minutes left a market hoping for the end of monetary policy tightening and a shift to monetary policy easing feeling foolish.

If you previously believed that the rate increases were concluded, it might be worth reconsidering that stance or hoping for a rapid deterioration in economic data. As things currently stand, such a scenario seems highly improbable because the economy remains rather strong. The Atlanta Fed GDPNow model is forecasting a second-quarter 2.9% real growth rate.

The combination of an even higher longer message from the Fed, and a still strong US economy, has led to a surge in the dollar’s value, as well as both nominal and real yields.

The combination of higher rates and a stronger dollar brings us back to a situation reminiscent of most of 2022, with tightening financial conditions likely to result in downward pressure on asset prices.