January flashlight for the FOMC blackout period

Summary

Pieces have fallen into place since the FOMC's last meeting on December 14 to allow the Committee to dial back its pace of tightening further. Consumer prices have decelerated in recent months, and the labor market has shown signs of cooling, although it generally remains tight.

The FOMC raised its target range for the federal funds by 75 bps at four consecutive meetings between June and November, but it downshifted to 50 bps in December. We look for the Committee to hike rates by 25 bps on February 1, bringing the target range for the federal funds rate to 4.50%-4.75%. Fed policymakers appear to be entering the fine-tuning phase of this tightening cycle.

However, inflation remains too high for the Fed's liking, and most FOMC members continue to state publicly that rates need to go higher to bring inflation back to the target of 2%. We look for the Committee to raise its target range for the federal funds rate by 25 bps at each of its meetings on February 1, March 22, and May 3. If realized, the target range would end the tightening cycle at 5.00%-5.25% in early May.

Given recent signs of slowing economic growth, we readily acknowledge that rates may not rise quite as high as we envision. But we believe that in order to bring inflation back to 2% on a sustained basis, the FOMC will maintain its target range at the terminal rate longer than most market participants currently expect. We do not expect the FOMC to begin cutting rates until early 2024.

The post-meeting statement already notes that policy will need to be "sufficiently restrictive to return inflation to 2 percent over time." We can envision the Committee adding the phrase "for some time" to "sufficiently restrictive" in the February 1 statement. Chair Powell could also stress this intention in his post-meeting press conference.

This stronger statement of the FOMC's intentions, should it be added, would hammer home the point that the Committee likely will not be easing policy until there are unambiguous indications that inflation is returning to 2% on a sustained basis.

We look for the FOMC to once again maintain the current pace of quantitative tightening by allowing up to $60 billion of Treasury securities and up to $35 billion of mortgage-backed securities to roll off its balance sheet every month.

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