The Fed raises rates, again

The Federal Reserve raised short-term interest rates by one-quarter of a percent, or 25 basis points, to a target range of 5.25% to 5.5%. In Fed Chairman Powell’s own words during the press conference, this level of interest rates is likely to weigh on economic activity.

While Chairman Powell acknowledged the “risks on both sides” of raising rates too much or not high enough, the Fed’s focus remains on inflation fighting and bringing inflation down to its 2% objective. That process, Chairman Powell affirmed, “has a long way to go.” He also indicated that at the next Fed meeting to set interest rates, which isn’t until September, raising rates again or holding steady at current levels are both possible. While the message was balanced, the Fed’s finger remains on the trigger.

Interest rate outlook

Market expectations, based on futures market pricing, places approximately 4-to-1 odds that the Fed will hold steady in September rather than raise rates again. That expectation of holding steady is in line with forward-looking indicators of inflation which continue to show moderation. This is evident in input prices, wage growth, survey measures, and spending data.

The Fed’s focus is more on backward-looking hard data, which, at least in the case of June CPI data, also surprised to the downside. Chairman Powell noted this favorable inflation reading, but he clearly needs to see confirmation in subsequent months. We do expect that upcoming inflation data will be sufficiently cool to allow the Fed to remain on hold not only in September, but through year end as well. The Fed’s longer-term projections indicate a tilt toward cutting interest rates sometime in 2024, which could come just as the economy is picking up momentum.

Macroeconomic effects and outlook

The challenge at hand is to slow the economy enough to cool inflation without causing downward momentum to develop. This soft-landing scenario is a delicate but viable path, but one which has been rendered less steady by the current interest rate increase. There are signs of slowdown by both consumers and corporations, but as long as the labor market remains healthy and overall credit conditions don’t choke off the economy, we believe that significant downward momentum is unlikely. Nonetheless, a coming slowdown combined with high valuations and a strong equity market run-up calls for an approach that is balanced with respect to risk and seeks out opportunities for diversification.