NEW YORK (Reuters) - The Federal Reserve kept interest rates unchanged on Wednesday but signaled in new economic projections that borrowing costs will likely rise by another half of a percentage point by the end of this year as the U.S. central bank reacted to a stronger-than-expected economy and a slower decline in inflation.
The new projections by the Federal Open Market Committee added a hawkish tilt to Wednesday's interest rate decision, showing policymakers at the median see the benchmark overnight interest rate rising from the current 5.00%-5.25% range to a 5.50%-5.75% range by the end of the year. Half of the 18 Fed officials penciled in their "dot" at that level, with three seeing the policy rate moving even higher - including one official who sees it rising above 6%.
MARKET REACTION:
STOCKS: The S&P 500 was recently up 0.1%, reversing earlier losses.
BONDS: Benchmark 10-year note yields rose to 3.823%; The 2-year note yield rose to 4.758%
FOREX: The euro rose 0.4% and the U.S. Dollar Index was down 0.3%.
COMMENTS:
QUINCY KROSBY, CHIEF GLOBAL STRATEGIST FOR LPL FINANCIAL, CHARLOTTE, NC
"Powell is doing an excellent job walking the monetary tightrope, staying close to the center and being balanced. He’s acknowledged that inflation is edging lower and said the skip was “prudent.” Moreover, he stressed that the Fed’s mandate is to restore “price stability,” but that the Fed is data dependent….. The market is responding to the lack of a pre-determined move higher in rates."
"He’s also reinforcing that two percent inflation must come down over time, but he doesn’t think it will require weakening the labor market dramatically. This matches with his earlier speeches."
BRIAN JACOBSEN, CHIEF ECONOMIST, ANNEX WEALTH MANAGEMENT, MENOMONEE FALLS, WISCONSIN
“This skip was so well telegraphed they should have just skipped the meeting entirely. They really wanted to underscore that this is not just a pause, but a hawkish one, which is why the year end federal funds rate forecast was raised to 5.6%."
"The differences in opinion about the outlook are so large you could drive a garbage truck through their year ahead forecasts. Of course, those forecasts are about as good as what you’d find in the back of a garbage truck. An unprecedented shock that led to an unprecedented stimulus that led to them being late to hike and launching an unprecedently aggressive hiking campaign means they should just take the rest of the summer off and gather their thoughts. I wouldn’t take the forecast for two more hikes too seriously. They have no idea what the data will be, so they’re driving blind.”
ANDRZEJ SKIBA, HEAD, U.S. BLUEBAY FIXED INCOME, RBC GLOBAL ASSET MANAGEMENT, NEW YORK
“There was a broad expectation of a hawkish pause, but the contents so far were even more hawkish than the market expected. Because you have the double impact of the dot plots suggesting two more hikes this year, and there’s only four more meetings left for the year.
“From this statement it does read like at least we’re going to get one over the coming meetings. While the market expected a hawkish pause, this is even a little bit more hawkish than market participants anticipated and that’s why you’re having a negative reaction in risk assets.
“The market’s surprise was to the extent it’s two rather than one in the dot plot.”
GENNADIY GOLDBERG, INTEREST RATE STRATEGIST, TD SECURITIES, NEW YORK
“It’s certainly the most interesting rate hike of the cycle so far. I do think the Fed’s trying to have their cake and eat it too by holding rates steady but penciling in two more rate hikes in the summary of economic projections. So, it does suggest that the Fed is looking to tighten policy further, but the big question is can the Fed credibly commit to two more rate hikes if they just decided to actually hold rates steady. And I think it’s going to be a very difficult communication challenge for them, because it’s going to be hard to convince the market that they are quite hawkish even though they’ve actually just held rates steady for the first time in this hiking cycle.”
“I do think that the market is going to be quite choppy on this, I think it’s going to be hard to trade simply because there’s a credibility question with the Fed and whether they can continue to hike if inflation data continues to gradually moderate, if labor market data continues to gradually moderate, and really what the threshold is.”
“It is a somewhat strange message because they are trying to be quite hawkish but also very careful so it’s difficult to see exactly how much of their projected rate hikes will filter into actual hikes.”
“It still begs the question that if you think that the unemployment rate is going to be lower than initially expected and inflation is going to be higher than initially expected, why not hike now? Why wait? And what is the threshold for further rate hikes? That’s really the big question that the market will have to answer in the months ahead.”
ELLEN HAZEN, CHIEF MARKET STRATEGIST, F.L.PUTNAM INVESTMENT MANAGEMENT, WELLESLEY, MASSACHUSETTS
“The market has got this right and the Fed is catching up to the market, certainly the Fed is catching up to the underlying indicators. So they finally lowered their unemployment rate a little bit, they raised their GDP a little bit and they raised their inflation so they are really catching up with what the data is already telling us.
“In terms of the market reaction we are seeing equities slip so it’s a little bit of a disappointment and the biggest surprise for me the federal funds rate December projection all the way up to 5.6%, so a whole 50 basis point increase, I think the market was expecting 25 bps.
“A number of the Fed voting members and others have been out with fairly hawkish comments recently, including Kashkari, including Logan, including Waller, and yet this was a unanimous decision, there were no dissenters. The fact that the language was fairly hawkish was Powell’s way to bring them along and not have them dissent by wanting to raise rates, but in order to get them to go along to have a unanimous opinion he had to make the language a little sharper and maybe the market was a little surprised that that. “
GEORGE YOUNG, PORTFOLIO MANAGER, VILLERE & CO, NEW ORLEANS
"This a pregnant pause, meaning that they said they're going to pause hikes today but they're going to increase later. Obviously, equity markets don't like that. For the consumer, that means you've got inflationary problems again. But I think the bigger story is the inverted yield curve we're seeing right now, which is signaling a recession. That's where the Fed has to balance between inflation and a recession. That’s why I think it’s a pregnant pause because they’ve taken a wait-and-see attitude and signal they’re going to increase rates. If they do that, it’s going to be bad for the equity market."
ANGELO KOURKAFAS, SENIOR INVESTMENT STRATEGIST, EDWARD JONES, ST LOUIS
"We're seeing a more hawkish pause. For the first time in this cycle the Fed is not hiking rates but the market is looking ... clearly looking at the 2023 estimate that implies more than one additional hike."
"In this way policy makers can maintain some flexibility depending how the economy and inflation progress. "Looking at the resilience of the economy keeps the Fed on high alert rather than letting its guard down too soon."
"The message is clear from CPI and PPI that we continue to see progress but with inflation still above the 2% target the Fed cannot yet declare victory."
"The Fed is calling for a more resilient economy this year and a smaller rise in unemployment. That fits with the theme that things are holding up better. From a Fed perspective its good news the economy is resilient but they want to achieve some kind of slowdown."
"The market realizes that the Fed is getting close to the end of the tightening cycle ... They've done a lot in a short amount of time. It enables them to be a little more patient."
"The more surprising thing was the median forecast calling for 2 more hikes rather than one. As we put into perspective how much they've hiked already it's not as hawkish as this might have appeared when they were starting up. However, the idea of any rate cuts is off the table for this year."
MICHAEL BROWN, MARKET ANALYST, TRADERX, LONDON
"A hawkish skip from the FOMC this evening, with rates left unchanged as expected, but the Committee signaling that at least two further rate hikes are likely to come before year-end via the 50 bps upward revision to this year's median dot."
"Clearly, the strength of the labor market, and ongoing concerns over the stickiness of core inflation are continuing to drive policymaking for Powell & Co, with a victory lap to celebrate the inflation beast having been slain still some way off."
"Markets have, unsurprisingly, reacted hawkishly as the decision dropped - firmer USD, higher Treasury yields, and marginal downside in stocks - a pattern that, if Powell continues the hawkish tone at the press conference, could set the tone for trade over the rest of summer."
WHITNEY WATSON, GLOBAL CO-HEAD OF FIXED INCOME, GOLDMAN SACHS ASSET MANAGEMENT (emailed note)
“Today’s decision to pause on policy actions was consistent with recent labor market and inflation data. But with the economy proving resilient, downside risks from banking stress fading, debt limit uncertainty behind us and inflation still hovering above target, we are unsurprised that the Fed has also hinted that “additional policy firming” may be warranted, with the median projection for the Fed funds rate at the end of the year rising from 5.1% in March to 5.6%.
"Job openings are on a moderating path, average hourly earnings are trending down and the composition of the CPI inflation report for May is encouraging.
"The upside surprise in last month’s core CPI reading was driven by used car prices, however, the Manheim Index—a timely measure of the outlook for used car prices—points to a moderation ahead. Importantly, the slowdown in shelter inflation was sustained and the breadth of price rises softened further. Indeed, the Cleveland Fed trimmed mean CPI inflation measure—which omits volatile categories—has fallen from an annualized monthly peak of 9.5% in October 2021 to 2.8% in May.”
SAM STOVALL, CHIEF INVESTMENT STRATEGIST, CFRA RESEARCH, ALLENTOWN“The market has sold off because investors are concerned that there will be possibly at least two more rate hikes between now and the end of the year with no rate cuts.”“Some people were expecting that the Fed would actually pause this month, but also not raise rates anymore, that they were high enough. While others were thinking that they'll pause at this meeting but maybe add one more hike in July and then that would be it. However, it does seem as if the FOMC members have become even more hawkish since the last meeting, and I think that has taken investors by surprise.”
PAUL NOLTE, PORTFOLIO MANAGER, KINGSVIEW INVESTMENT MANAGEMENT, CHICAGO
"You're looking at an economy that is in some areas running very hot, the services side especially and they're (Fed) waiting for unemployment to turn higher, which it hasn't really."
"It's not a surprise to see the market sell off a little bit because they have been so bullish in anticipating that the Fed is going to continue to be dovish and it has been proven wrong consistently."
MICHAEL JAMES, MANAGING DIRECTOR, EQUITY TRADING, WEDBUSH SECURITIES, LOS ANGELES
"The market was pretty overbought going into the meeting and any sign of hawkish commentary was going be negative. We received it and that's the initial knee jerk reaction. We need to get more color from Chair Powell but the initial statement clearly reads more hawkish than the market was prepared for, at least coming into the statement."