Despite Resilient Data, Fed Signals Prolonged Pause

Tighter financial conditions prompted Federal Reserve officials to take a step back from data dependence, and suggest a higher bar for future hikes.

The Federal Reserve delivered another pause in November, and Fed Chair Jerome Powell declined to nudge market expectations toward the additional rate hike in 2023 that many Fed officials projected in September. This comes despite U.S. economic activity and inflation indicators having accelerated in recent weeks to levels that likely remain too strong to be consistent with Fed’s inflation target. Instead, Powell indicated that recent strength may be elevated due to post-pandemic normalization in immigration, along with improvement in labor force participation

By not trying to nudge up the relatively low market-implied probability of a rate hike in December, Powell reinforced the current market pricing of the December meeting outcome. As a result, we believe most Fed officials now do not expect to hike in December, and the onus is on the data between now and then to knock them off of that track.

While U.S. GDP growth was incredibly strong in 3Q at 4.9%, according to the Bureau of Economic Analysis, we expect a significant slowing in 4Q, which, based on Powell’s press conference, likely won’t be enough to prompt additional tightening. Instead, the Fed appears happy to remain on hold, and watch and see how the economy evolves early next year. The pace and extent of the U.S. slowdown will likely dictate future rate decisions.

Taking a step back, the central bank appears to be balancing the resilient economic data seen in recent months against tighter financial conditions (including higher borrowing rates for a range of assets, a stronger U.S. dollar, asset prices, and more). Based on the tone of the November meeting, tighter financial conditions seem to be winning out for Fed officials for now.