Are We There Yet? The Perennial Question of the FOMC Road Trip

Executive summary:

  • Federal Reserve leaves rates unchanged at the June meeting but hints at the possibility of further tightening this year.
  • We think the Fed will do what it takes to combat inflation, but with interest rates already deeply into restrictive territory, the remaining upside to the path of interest rates will likely be limited. Further rate hikes also increase the risk that the Federal Reserve tightens too much.
  • Once a recession materializes, the Federal Reserve would likely be forced to aggressively cut interest rates, which would benefit holders of U.S. Treasuries.

The bottom line: We continue to believe that U.S. Treasuries can have an important role to play in diversifying your portfolio

Are we there yet? The shrill voice of your kids shouting this question from the back seat of your car catches your attention. You look at your GPS, and say, 30 minutes to go. That calms them down, until 15 minutes later they start asking the same question. Ah, the joys of the summer road trip. But it could be more challenging.

The Fed’s long road trip sees a brief rest

The Federal Reserve Open Market Committee (FOMC) has been on a road trip of its own. In an effort to bring inflation back down to its 2% target, the FOMC has been raising rates at every meeting since March 2022, before finally deciding to leave rates unchanged at the June FOMC meeting. The decision to rest this month was broadly in line with what markets had been expecting immediately before the meeting. We think it’s understandable that the FOMC decided to leave interest rates unchanged today. With the FOMC having already been on a long road trip (rates have climbed by more than 500bps), it needs to take some time to assess how economic activity is responding to its decisions before proceeding further.

We might not be there yet – FOMC hints at further rate hikes to come

The June FOMC projection materials suggest that despite the long journey already traveled, it’s possible that we might not yet be at the peak federal funds rate. The median projection for the 2023 federal funds rate has moved up to 5.6%, compared to 5.1% in the March FOMC projection. That would suggest that we could potentially see two more rate hikes by the end of the year.

It's important to remember, though, that FOMC projections are merely forecasts, rather than a pre-commitment. Chair Jerome Powell himself underscored this point, indicating that the FOMC had only made a decision about this meeting and that the July meeting would be “live”, meaning that while the Fed could resume hikes, they could also instead leave rates on hold for even longer.

Throughout the rate hiking cycle, the FOMC has emphasized that they would be data-dependent in their policy actions. Although lagging economic indicators such as overall employment in the U.S. have still been resilient, leading economic indicators have already begun pointing to signs of weakness that could lead to a recession sometime between now and 12-18 months from now. For a more detailed analysis of our economic views, refer to our May Economic Update and our upcoming 2023 Q3 Global Market Outlook (published on June 27).