Fed turns off autopilot on rate hikes – but has it reached cruising altitude?

The US Federal Reserve (Fed) raised rates by 25 basis points to take the Fed funds policy rate to a range of 5 to 5.25% in line with market expectations.

But the key change came in the official policy statement, in which the Fed dropped the phrase “the committee anticipates some additional policy firming may be appropriate”. It now says “in determining the extent to which additional policy firming may be appropriate…the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”.

Going forward it looks like policy will become more data-driven and will depend on how events unfold.

So, the Fed is turning off the rate hike autopilot, but has cruising altitude been reached as far as rates are concerned?

Clearly, this will now depend on the growth and inflation figures, particularly the latter. However, an insight into the Fed’s thinking was provided by chair Powell in his post-meeting press conference, where he said that he believed that the level of interest rates was now restrictive at around 2% in real terms.

Add on ongoing asset sales (quantitative tightening) and the additional tightening of credit conditions as a result of recent events in the banking sector, and he believed that policy was now tight.

Inflation is still currently too high and the labour market needs to slacken, but this suggests Powell is comfortable with waiting for the lags from policy to work their way through to the economy. On this basis the bar for further rate hikes has become higher.

Our view is that we will now have seen the peak in rates and that the next move will be down. But we do need to see the modest slowdown year to date turn into something more dramatic to create meaningful slack in the economy and return inflation to target.

Chair Powell refused to be drawn on the debt ceiling debate saying it was not important to today’s decision. However he did acknowledge that it was discussed as an adverse risk to the outlook.