Markets Are Finally Listening to Fed’s ‘Ongoing Increases’ Message

It’s been a busy month for investors and Fed watchers. On 1 February, after announcing a 25 basis point hike in the federal funds rate, the U.S. Federal Reserve went on to state that it anticipates that “ongoing increases” would be appropriate in order to move monetary policy into the restrictive range needed to put U.S. inflation on a path to return over time to the Fed’s 2% longer-run goal.

Two days later, a blockbuster U.S. employment report for January triggered an immediate repricing in bond markets toward a higher peak level for the fed funds rate. In the following week, a parade of Fed speakers led by Chair Jerome Powell consistently reinforced the “ongoing increases” message. Then last week, higher-than-expected data on U.S. Consumer Price Index (CPI) inflation and stronger-than-expected data on retail sales as well as additional remarks from Fed officials together triggered markets to price in not only the two additional rate hikes indicated by the Fed’s December 2022 dot plot (part of its Summary of Economic Projections), but also a material likelihood of at least one additional hike after that, which would bring the top of the range for the federal funds rate to 5.5%.

These developments illustrate well the interplay among data, destination, and market dynamics we are likely to experience in the year ahead as the Fed tries to engineer what we would characterize as a “softish” (if not soft) landing for the U.S. economy by ratcheting down aggregate demand growth into better balance with aggregate supply in its pursuit of its longer-run price stability mandate. Fed officials have asserted that the risk of doing too little to reduce inflation exceeds the risk of doing too much. But our view remains that they’ve already done most of the heavy lifting they will need to do before they pause rate hikes later this year, although as explained in a recent blog post by my colleagues Tiffany Wilding and Allison Boxer following the release of January CPI data, the risk is to the upside on the peak fed funds rate we will see in this cycle if progress on reducing inflation is slower than the Fed expects.

Understanding the Fed’s concerted efforts to tame inflation helps explain much of what we’re seeing in markets and the broader U.S. economy, and informs what to watch and what to expect over the coming year.