Financial News Highlights
- The FOMC downshifted its tightening race in December, raising the policy rate by 50-bps, bringing the operating band to 4.25%-4.5%.
- The FOMC’s Summary of Economic Projections showed a less optimistic economic outlook, accompanied by higher inflation. The median consensus on the Fed Funds rate was lifted by 50-bps for 2023, implying a terminal rate of 5.25%.
- November inflation data showed a further softening in price pressures, with core CPI rising 0.2% m/m and the 12-month change falling to 6% y/y. Retail sales for November were weaker than expected (-0.6% m/m), recording its largest monthly decline in 11 months.
Slowing, But Not Stopping
Phew, whatta week for financial news! The headlines included further evidence of softening inflation, wanning consumer momentum and the much-anticipated December FOMC interest rate announcement. The Fed met market expectations, increasing the policy rate by “only” 50 basis-points (bps), bringing the upper-bound to 4.5%. That marked a slowdown from the 75-bps pace undertaken at the four prior meetings, but still stands as a historically fast pace of policy adjustment (Chart 1).
Beyond the interest rate announcement, the FOMC also released updated economic projections. Relative to the September assessment, Committee participants now expect growth to be considerably weaker in 2023 (0.5% vs 1.2%) and the unemployment rate slightly higher (4.6% vs. 4.4%). Despite the more downbeat outlook, policymakers view price pressures as having become more entrenched, and upgraded the inflation outlook through 2024. As a result, the FOMC signaled rates are likely to move at least 50-bps higher than previously expected next year – implying a terminal rate of 5.25% – with cuts not beginning until 2024.
In the press conference, Chair Powell struck a somewhat hawkish tone. When asked about the recent easing in financial market conditions, Powell stated that the Committee looks through near-term swings, but emphasized the importance of market conditions aligning to the Fed’s intentions. Moreover, Powell was quick to direct focus to the upward revision to the “dots”, reiterating that the Committee’s view on inflation remains skewed to the upside and thus future projections could still show an even higher terminal rate. Despite this deliberate signaling, market participants still believe that the Fed will begin cutting rates late next year.
Investors current assessment might be somewhat biased by November’s CPI data, which showed a further cooling in inflationary pressures. Core inflation rose by 0.2% m/m – a tick below market expectations – bringing the 12-month change to 6.0%. Core goods prices declined for a second consecutive month, while price growth across services continued to be led by outsized gains in shelter. That said, even after removing its effects, most other service categories continue to show strength. This cuts to the heart of the issue. With goods prices appearing to have rolled over and the shelter component expected to slow in H2’2023, the move down towards 3% inflation by the end of next year is feasible. However, until we see a more meaningful slowdown in hiring activity, leading to a cooling in wage pressures, many labor-intensive service sectors will continue to run hot – preventing inflation from moving back to 2%.
Though the cumulative impact from higher rates hasn’t yet hit hiring intentions, November retail sales showed consumer momentum may be wanning. Sales fell 0.6% m/m – its biggest monthly drop in nearly a year – with notable declines in holiday categories including, electronics, clothing, and sporting goods. As we noted in our Quarterly Economic Forecast, it was unrealistic to assume the recent strength in spending would continue indefinitely. A broader demand adjustment needs to occur over the coming quarters in order to restore price stability. It would appear we are nearing the precipice of that adjustment.
Thomas Feltmate, Director | 416-944-5730
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