US: FOMC delivers a hawkish hold – UOB

The Fed in its 19/20 Sep 2023 Federal Open Market Committee (FOMC) meeting, unanimously agreed to keep the target range of its Fed Funds Target Rate (FFTR) unchanged at 5.25%-5.50%. This was the second pause in the Fed’s current rate hike cycle after having raised rates for ten meetings in a row before taking a first pause in June followed by another 25-bps hike in Jul. The Fed also voted unanimously to keep the interest rate paid on reserve (IOER) balances unchanged at 5.40%. 

The text of the Sep monetary policy statement (MPS) was largely a carbon-copy of Jul’s statement, with the significant change in the text only on the economy which is seen as more bullish, in line with the markedly upgraded GDP growth forecasts, especially for 2023. At the same time, the unemployment rate projection saw further improvement across the forecast period. The totality of the language of the text and the forecast adjustments on both the economy and unemployment rate in the Sep Summary of Economic Projections (SEP), reinforce the probability of Fed achieving that “soft landing”.

The most consequential release of the Sep FOMC is likely the Dotplot which indicated strong (but not unanimous) support among policy members for one more hike in 2023. Importantly, the Sep Dotplot showed 10 of the 19 FOMC members expect the policy rate to remain above 5% next year (versus just 6 members who echoed that view in Jun) while only 2 members expect rates to fall below 4.5% in the Sep Dotplot (versus 8 members indicated that in Jun FOMC). The implication is very clear, that expectations for rate cuts in 2024 has been drastically curbed and Fed policy could remain tight for a much longer duration than what we previously believed. 

FOMC Outlook – One More Hike In Nov & A Later Timeline For Cuts The latest Dotplot’s hawkish upward revision together with SEP’s “soft landing” projections is making us reassess (again) the terminal rate, especially against the still elevated headline and core PCE this year, and potentially higher energy prices adding to the price re-acceleration process. We now expect the Fed to hike one final time by 25-bps in the Nov 2023 FOMC and pause thereafter. This means, with the FFTR currently at 5.25-5.50%, we are adjusting our terminal FFTR level higher to 5.50-5.75%, which unsurprisingly is forecast to last through 2023.

We also expect the Fed rate cuts to be delayed till mid-2024 (from previous forecast of 1Q 24) and at a less aggressive pace of just 75 bps of rate cuts for 2024 (from previous forecast of -125bps). And while we think the Fed will hike once more, but as Powell alluded to during Sep FOMC press conference (“We’re fairly close, we think, to where we need to get”), the [hiking] cycle is near the end, we still hold the view the FFTR is unlikely to go to 6%.