What's next for stocks as Fed fully embraces 'higher for longer' mantra

© Reuters. What's next for stocks as Fed fully embraces 'higher for longer' mantra

As widely expected, the Fed’s Federal Open Market Committee (FOMC) decided to maintain its benchmark rate within a range of 5.25% to 5.5% on Wednesday. The central bank also did not rule out the possibility of a twelfth rate hike.

Hence, the updated forecast anticipates that rates will peak at a range of 5.5% to 5.75% this year, with a midpoint estimate of 5.6%. This information was outlined in the Summary of Economic Projections that accompanied the monetary policy statement. According to the CME FedWatch Tool, the market is assigning a 31.5% chance that the Fed will hike in November.

The Fed expects the benchmark rate to be at 5.1% next year. This suggests a scenario with just two rate hikes in 2024, compared to the previously projected four rate hikes. Interest rates are then forecasted to drop to 3.9% in 2025, higher than the previous projection of 3.4%. In 2026, rates are expected to further decline to 2.9%.

Inflation and Economic Outlook

The Fed now anticipates that the core personal consumption expenditures price index (core PCE) will average 3.7% for this year, a slight decrease from the prior forecast of 3.9%. In 2024, inflation is estimated to slow to 2.6%, remaining unchanged from the previous projection.

By 2025, it is expected to be at 2.3%, slightly higher than the prior estimate of 2.2%. Ultimately, the Fed projects that inflation will return to the 2% target by 2026.

The unemployment rate is forecasted to be 3.8% in 2023, which is lower than the previous estimate of 4.1%. However, it is expected to rise to 4.1% in 2024 and remain at that level through 2025, down from the prior forecast of 4.5%. By 2026, the unemployment rate is projected to drop to 4.0%.

The growth projection for this year has been raised significantly to 2.1%. This is more than double the previous projection of 1% that was made at the June meeting. The forecast for economic growth in 2024 has also been increased to 1.5%. This represents an upward revision from the previous projection of 1.1%.

5 Prominent Economists on Wall Street Reflect on FOMC Statement

JPMorgan: “The FOMC went beyond just leaning into the soft-landing narrative — they are now forecasting only a trivial weakening in growth and labor markets next year and beyond. Given this very rosy outlook it’s not surprising that the dots now project less easing in ’24 and ’25… We would be getting more concerned about the Committee walking into the policy mistake of overtightening if it weren’t for the fact that the more influential members are likely less hawkish than the median dot.”

Nomura: “We maintain our view that July was the last hike of the current tightening cycle. In our base case of a Q4 recession, this would likely not be a difficult decision. Even in a soft landing scenario, we would expect slowing inflation and ongoing moderation in the labor market to make any additional rate hikes a close call.”

HSBC: “We still do not forecast any additional rate hikes going forward. However, we have pushed out our projected timing for the first Fed rate cut (to Q3 2024 from Q2 2024). Moreover, we now project 50bp of cumulative rate cuts in 2024 (75bp previously). Our forecasted federal funds target range at end-2024 is now 4.75-5.00% (up from 4.50-4.75%). Over the course of 2024, we view the risks to policy rates as very much double-sided.”

Morgan Stanley: “We continue to see a soft landing for the economy, and remain more optimistic on the deflationary process compared to the Fed – where core PCE has so far unfolded in line with our outlook for 3.3% 4Q/4Q this year. The data flow will matter, and dictates our forecast for the funds rate, which sees the policy rate on hold into 2024 before the Fed begins quarterly 25bp cuts in March.”

BofA: “The forward guidance language was not altered, leaving the door open for additional hikes without making a firm commitment to raise rates further. This was very much in line with our expectations and leaves our Fed call unchanged: we expect one final hike in November, but it is a close call.”