Fed Watch – Rate hike lift-off brought forward to 2023

. First, the Committee raised its PCE inflation forecast for 2021 by a full percentage point – from 2.4% in March to 3.4% – following the exceptionally strong April and May readings. However, it also maintained in the policy statement that the current overshoot is being driven by ‘transitory factors’, and the PCE inflation projections for 2022-23 saw much more modest adjustments of only 0.1pp (to 2.1% and 2.2% respectively). This was in line with the expectations we outlined in our FOMC preview on Monday. In the press conference, Chair Powell continued to defend the Fed’s view on inflation against mounting scepticism, but in his opening statement, he also made some important comments. First, he said that “bottlenecks, hiring difficulties and other constraints could continue to limit how quickly supply can adjust, raising the possibility that inflation could turn out to be higher and more persistent than we expect.” In reference to such labour market bottlenecks, Powell later mentioned three factors that were hampering the full return of the labour force: 1) fears of taking public-facing roles due to covid; 2) the fact that many childcare facilities are still closed (and will remain so until September), and 3) the continued provision of generous unemployment benefits – which anecdotally is acting as a disincentive for workers to take on employment, but is something we have no hard evidence of as yet. These factors are compounding other non-labour related bottlenecks, which combined with strong demand are having an inflationary impact in some key categories. However, these are also factors that will dissipate in the coming months.

Two rate hikes now seen in 2023 – Powell followed these comments on inflation and bottlenecks with the remark that “if we saw signs that the path of inflation or longer term inflation expectations were moving materially and persistently beyond levels consistent with our goal, we’d be prepared to adjust the stance of monetary policy.” Indeed, the other key change in the Fed’s projections was in the path of the Fed funds rate: the median FOMC member now expects lift-off to begin in 2023. While change in the timing of lift-off was in line with our expectation, it was a little more aggressive than we foresaw – with the median projection now at two rate hikes in 2023 (in March, no rate hikes were expected in 2023). Our base case has for some time been that the Fed would deliver one rate hike in 2023, and we maintain that view. Finally, Powell was repeatedly questioned on the timing of a tapering of asset purchases, and he confirmed that this had been the ‘talking about talking about’ tapering meeting. However, he offered no further hints on the timing of an announcement. We think tapering is likely to be telegraphed at the Jackson Hole Symposium in late August, with a formal announcement coming at the September FOMC meeting, and an actual tapering of purchases taking place in Q4.