by Kathy Jones, Chief Fixed Income Strategist, Charles Schwab and Company Ltd.
As expected, the Federal Reserve raised its target range for the federal funds rate by 75 basis points to 3% to 3.25%, citing high inflation as its primary concern.
The "dot plot" which is a summary of estimates about the path of the fed funds rate by the 19 members of the Federal Reserve Open Market Committee (FOMC), shows a median expectation for the path or interest rates. It's a marked increase from the June estimates which suggested a peak rate (terminal rate) of 3.75% followed by a modest decline in 2024.
FOMC Dot Plot, as of 9/21/2022
Source: Federal Reserve, Summary of Economic Projections, September 21, 2022.
However, it's notable that the Fed's projection still shows the expectation that short-term rates will drop in modestly in 2024 and further in 2025. It's not the "hike and hold for a long-time" scenario many were expecting. It's indicating a sharper, shorter cycle with short-term rates falling back toward 2.5% over the long-run. Of course, these are just projections, as of today and there is a wide dispersion of views at the Fed. Nonetheless, it appears that the majority at the Fed see rates falling in 2024.
Economy: Recession risks rise
Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents
Source: Federal Reserve Board, 9/21/2022.
Notes: For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. The central tendency excludes the three highest and three lowest projections for each variable in each year. The range for a variable in a given year includes all participants' projections, from lowest to highest, for that variable in that year. Longer Run projections for Core PCE are not collected.
Implications
This is the fastest rate hiking cycle since the early 1980s
Source: Bloomberg. Federal Funds Target Rate - Upper Bound (FDTR Index), using monthly data.
Note: Lines represent the cumulative change in the Fed funds target rate from the start of each rate hike cycle shown. For the current cycle, the Fed funds target rate has risen 3%, from a 0.25% to 3.25%.
Past performance is no guarantee of future results.
Market reaction
The two-year/10-year yield curve drops to a new low
Source: Bloomberg.
Market Matrix US Sell 2 Year & Buy 10 Year Bond Yield Spread (USCY2Y10 INDEX). Daily data as of 9/21/2022.
Note: The rates are comprised of Market Matrix U.S. Generic spread rates (USYC2Y10). This spread is a calculated Bloomberg yield spread that replicates selling the current 2 year U.S. Treasury Note and buying the current 10 year U.S. Treasury Note, then factoring the differences by 100.
Fed tightening cycles are often characterized by high volatility, especially in riskier segments of the markets. With the Fed moving at a rapid pace, volatility is likely to remain high.